鐵山公司 (IRM) 2006 Q1 法說會逐字稿

Good day ladies and gentlemen, and welcome to the Iron Mountain Incorporated first quarter earnings 2006 conference call.

My name is [Onika] and I will be your operator for today.

.[OPERATOR INSTRUCTIONS]

At this time, I would now like to turn the call over to Mr. Stephen Golden, Director of Investor Relations.

Please precede, sir.

Thank you.

And welcome everyone to our first quarter 2006 earnings conference call.

After I have completed the morning announcements, Richard will give his State of the Company's remarks, then turn the call over to John for a financial review, followed by brief Q&A, and closing remarks.

Per our custom, we have a user controlled slide presentation on the investor relations page of our web site at www.ironmountain.com.

As John will discuss more fully during his comments, we have moved a few of our standard slides to an appendix at the end of our presentation for your reference.

Referring now to slide 2, today's earnings call and slides presentation will contain a number of forward-looking statements, most notably our outlook for our 2006 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 provide additional information and the reconciliations of this non-GAAP measure to the appropriate GAAP measures as required by Reg G at the investor relations page of our web site, as well as in today's press release.

With that, I would like to introduce Richard Reese, our Chairman and CEO, for his State of the Company remarks

Good morning.

Thank you, Stephen.

Good morning to everybody, and welcome to our call.

We recognize that our first quarter results announced this morning, come as a surprise to most of you.

And therefore I want to take some time on this call to explain exactly what's going on in our business.

Hopefully at the end of this call you will take away 3 important things.

First, our businesses are performing well across the board.

I am as excited as I have ever been about what we're doing and what we see in the marketplace.

In particular, we're encouraged by the growth rates that we're achieving in all of our businesses.

Second, we are following our plans previously communicated in Investor Day and at the year-end earnings call.

We are continuing to invest in the business, and increasingly those investments are coming through the P&L in the form of investments in revenue growth, which continues to accelerate, new products and services to enhance long-term growth, and internal projects to bolster infrastructure to support an even larger business and to drive future margin growth through more efficient operations.

And third, after evaluating our Q1 results, and given the combination of these factors, strong growth opportunities and important investments that we are making, we've decided to revise downward our OIBDA outlook for the year.

I expect my optimism may raise questions for some since we are reducing our outlook for the year.

As reported in our press release this morning, despite strong revenue performance, in fact the strongest internal growth rates in nearly 4 years, OIBDA came in at the low end of our range.

At the same time, I am pleased about the performance of our business units.

Across they board they are performing according to plans.

They're not underperforming.

But due to circumstances related to the reorganization of our North American businesses, we are unable to clearly see the aggregate impact of our investment initiatives in our near-term results.

Let me give you some data and explain what I mean.

From revenue, we remain biased for growth at Iron Mountain.

Internal growth rates are the strongest they have been in nearly 4 years as our prior customer facing investment build-out is paying off.

This strong performance is across the board and led by storage, our key business driver.

North American box storage is trending up and is at its highest level since 2001.

Europe, where we've said for some time we've been investing in revenue generation, is strengthening.

And they've had their highest internal growth since we doubled that business with the acquisition of Hays.

Latin America remains very strong.

Shredding continues to post great growth.

And Digital posted total internal growth at 27%, led by storage growth of 40%.

Our operations are also doing well.

And gross margins are in line with our expectations.

So as I've said, our business units are running well with strong revenue and gross margin performance.

So let me talk about overhead.

Our overhead growth is an issue for the quarter, one that will impact the remainder of the year.

It is up as compared to Q1 2005 by 120 basis points.

Although we expected most of this increase, we exceeded our expectations.

Primarily in 3 main categories, all of which relate to investments and future growth.

First, overhead related to acquisitions.

The overhead contributed by the LiveVault acquisition, completed in December, added to overall overhead gross since we had the higher overhead costs in relation to revenues the Company as a whole.

Second, overhead related to our North American reorganization.

We reorganized our North American physical businesses from 2 separate divisions into 1 consolidated business unit at the market and overhead support levels.

As we have previously communicated, this reorganization was driven by customer need first and operational synergies second.

Our customers want us to serve them and face them from a single organizational point.

It was a massive undertaking to rearrange all of our field organizations, change management relationships, and information reporting processes.

As part of this change, we added to our overhead some additional management and staff functions to help us drive future efficiencies in margin, which we are confident will come.

And last, overhead investments to focus on our largest revenue opportunities, our customer facing costs increase faster than revenues.

This increase came from 3 factors.

First, in our physical business, we chose to change our staffing to focus more sales staff on the larger accounts where we have demonstrated higher growth rates with more resources.

Although total sales headcount in this group grew slower than revenue growth, the move to a mix of higher compensated salespeople and related account management support costs per person resulted in onetime increase in cost levels.

Based upon our prior work in this large account arena, we expect this investment to produce a substantial payback in the form of higher sales efficiency and increased growth.

Second, we launched a new U.S. federal government services group to sell to a new sector.

Previously, we have been effectively barred from storing hard copy records for the United States Government.

And therefore had very little focus on that market.

However, due to a recent rule change allowing government agencies to outsource record storage needs, we now have available to us as a large new market opportunity.

And we want to take advantage of this opportunity now.

And the third contributor was an increase customer facing costs as we continued the expansion of our digital sales force.

The digital business has a selling cost structure of 27% of revenue as compared to 5% for the physical business.

It also has a substantially higher growth rate.

The digital sales force growth came mainly from the integration of LiveVault sales force and expansion in Europe of our digital team over there.

Clearly we are optimistic about our prospects.

We are investing on many fronts to build a stronger, growth oriented, more valuable Iron Mountain.

At the same time, I realize that many of you expected more OIBDA given our strong revenue performance for the quarter.

So let me explain.

As those of you who known me for some years are aware, I built this business on the principles that when I saw a market opportunity, we'd attack it.

And I see opportunity in this market right now.

I have added management depth, which is providing us with the capability of doing more to build the business on more fronts simultaneously than we have ever had before.

This is a good thing for us and for you.

But I opened up too many investment fronts.

Just when I poured on the coals and asked the organization to run fast towards a new world, broader in scope, focused on our customers, and internal growth, we also undertook the massive reorganization of our North American businesses.

This integration was on the same scale as the integration of Pierce Leahy or Hays.

And the organization is doing a great job.

However, the reorganization impaired our ability to forecast, one thing we have been historically good at.

The integration created a significant challenge for our team as they worked during Q4 last year to budget the business for 2006 on a different organizational structure for all our overhead costs in North America.

This involved moving thousands of people into new call centers in a new reporting structure than that which is represented in our historical data.

The budgeting process ran well into January and the new budget was not fully uploaded into our systems and reconciled with the new structures until sometime late in the Q1.

When we last issued guidance, we had the benefit of January revenue only, which looked strong.

And we did not have the benefit of full analysis of our new budget nor comparative trending analysis on overhead at a granular level.

We're moving fast and momentarily lost visibility of the combined impact of our plans.

In hindsight, we could have made some different decisions to slow the investment process rather than push faster.

Our continued enthusiasm for the opportunity bolstered by strong revenue performance and clouded by the reduced visibility we had during this period got in our way.

So what does all this mean for the future?

Please understand how we run this business.

Our view is to drive value for customers and employees and the results will reward the shareholders.

I believe that the investments we are making follow our criteria.

And the fact that we have accelerated the pace of bit should bring greater returns sooner.

We believe that we can continue the revenue momentum that we have established.

Storage internal growth should remain at or near 10% for the year.

Total revenue internal growth would follow except for a tough comp in services that we faced in the third quarter.

As we have previously mentioned, the last year in the third quarter, our digital business completed a large $10 million data restoration project.

And this type of project is not likely to be repeated.

This comp will drag down internal growth rate a bit on a total basis.Our ability to forecast is improving now that the reorganization is settling and it is expected to improve going forward.

Iron Mountain is now a much broader portfolio of business lines and geographies than in the past.

And even though they all possess similar annuity characteristics, they're varying growth rates, differing margin structures, and maturing along the strategic paths can cause the sum of the parts to behave in different ways in the short run.

And we want to get better at understanding and forecasting that.

So let me talk about our new forecast and new guidance.

Although John will go through the details in a moment, let me explain why we are reducing our outlook for the year.

We now have a clearer view of the year and can see our digital business in not likely to have a large data restoration project like we had last year.

In fact, analysis of our pipeline for projects suggest that data restoration revenues looks weaker as compared to last few years as a direct result of less litigation in the financial sector.

In addition, we expect slightly lower license sales for the year than our original budget.

Our license product continues to have strong growth, but our original budget was too optimistic.

On the cost side, our digital storage has grown significantly.

However this high growth rate has, during this high-growth we have experienced more costs to support the systems and our IT costs are going to run ahead of plan for the year.

We are currently developing a next-generation solution that is focused on the lowest cost and high scale in the market.

And we expect this solution to come online sometime in 2007.

The combined impact of these factors results in a reduction of our digital segment outlook by $10 million of revenues and $7 million of contribution for the year as a whole.

The balance of the reduction of our outlook is driven by the same factors that cause Q1 overhead to run ahead of guidance, particularly the customer facing increase, which John will discuss in detail.

I will now turn the call over to John so he can walk you through the numbers, and then we'll come back and take your questions.

Thank you, Richard.

On slide 3 is my agenda for this morning, and there are a few changes.

After a brief look at the major P&L line items, I'll spend some time discussing revenue and overhead in more depth.

Then, we will go right into revised guidance for the year.

I'll finish with a review of CapEx and cash flow.

Because we have a lot to discuss on this call, I have moved a few of our standard slides to an appendix for your reference.

Let's move to slide 4 and review the key financial messages for today's call.

In the first quarter of 2006, Iron Mountain demonstrated solid, fundamental operating performance.

Our revenue and field operations were particularly strong, but we also saw increased investment through the overhead line.

Here are the key messages for today's financial review.

As you've heard Richard say in his remarks, our revenue performance was strong across all geographies and product lines, driven by accelerated storage internal growth in the North American physical businesses.

Our gross margins were as expected.

Our overhead ran ahead of guidance in the quarter, driven primarily by higher investments in our customer facing organization, the dilutive impact of a recent acquisition, and the reorganization of our North American businesses.

And given the impact of these investments, we have reforecast the year, and we are revising our full-year 2006 guidance.

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

Slide 5 compares results for this quarter to Q1 of 2005.

I will move quickly through these next 2 slides as I will be discussing revenue OIBDA in greater detail later in my presentation.

The important item to note here is that gross margin was as expected and is inline with the first quarter of 2005 before the dilutive impact of our recent acquisitions.

These acquisitions, which are all standalone in nature and do not benefit from any fold in synergies, are key components in our overall strategy.

They bring us to new geographies such as Australia, New Zealand.

They introduce shredding in the UK, document management services in France and Spain, and secure leadership in a proven line of business in the case of LiveVault.

Together these acquisitions were responsible for approximately 40 of the 50 basis point decline in year-over-year gross margin.

Much of the margin pressure from these acquisitions was due to integration costs such as those associated with the real estate rationalization program in Australia.

We expect these businesses to increase their gross margins over time.

Additionally, modestly higher energy costs factored into the reduced gross margin.

Depreciation of $45 million and amortization at $50 million for the quarter were both in line, excuse me, $5 million for the quarter were both in line with expectation.

Depreciation will rise modestly over the next few quarters, as most of our CapEx spending will occur later in the year.

Moving to slide 6.

I'll just mention that interest is in line with expectations.

Our net debt has increased slightly to $2.52 billion since year-end, but our weighted average interest rate has declined to 7.3%.

Our standard slide with the various debt metrics is one that I will not be speaking to today but which can be found in the appendix.

Not much new is going on here.

In Q1 2006, we have other income of $3 million or $0.01 per diluted share versus other expense of $5 million or $0.02 per diluted share in Q1 2005.

In both periods the other income or expense is the result of the foreign currency exchange rate fluctuations as we mark our inter-company debt to market and $1.5 million of other non-operating expense.

Now let's move to slide 7 and began a detailed look at our revenue performance for the quarter.

Our revenue growth for the quarter was strong.

First let me set some context.

Our Company has a portfolio of businesses and therefore of revenue streams.

The common characteristic of our main service lines is that they are based on predictable, recurring revenue streams that support complementary services.

Our North American physical businesses, business records management, and offsite data protection, which we have just reorganized into one business unit, represent more than 70% of our total revenues.

Layered on this foundation are the newer growth legs, secure shredding, international records management, and digital services.

We have said that we expect the core physical businesses in North America to have internal revenue growth rates in the mid to high single digits.

And when combined with new, faster growing services and a modest level of acquisitions, we could achieve total revenue growth of more than 10%.

That is exactly what we saw throughout 2005 and into the first quarter of 2006 as total revenue grows 12% on the foundation of 10% internal growth.

The key message here is that for the second quarter in a row, we had a total storage internal growth rate of 10%.

Storage revenue is a key driver in our industry and drives approximately 75% of our gross margin dollars.

More important is the make up of that 10% internal growth rate.

It is being driven by strong internal growth in the North American box business.

For the first time since 2001, the storage revenue internal growth rate for that business exceeded 8%, having accelerated for each of the last 6 quarters.

Likewise, our more physical data protection storage revenue growth rate also remains strong.

Our growth investments in our shredding, international, and digital business are working.

Iron Mountain Europe showed continued improvement, posting its highest storage growth rate since Hays entered our internal growth calculus in the first quarter of 2005.

Our digital services also posted 40% storage internal growth for the first quarter, driven by our various digital offerings across the board.

Moving now to slide 8, you can see that all of our internal growth rates are near or above the top end of our forecasted ranges.

Let me now focus on service revenue.

Of particular note here is the continuation of the solid internal growth we are seeing in our core services, especially in North America.

The data protection business is running strong, and the core service revenues in the box business continue to grow in line with storage revenues.

Our secure shredding business continues to do very well here in North America, growing in the high teens internally.

And we are very pleased with the early performance and market position of our new shredding business in the UK.

Our complementary services revenue had a nice quarter, growing internally at 7%, driven by strength in our fulfillment business, improvement in North American project work, and a favorable comparison in our European public sector business.

Offsetting these improvements was a decrease in data restoration projects in our digital business.

I want to point out that digital data restoration projects are driven almost exclusively by litigation, and we are unable to stimulate demand for these services.

After a tremendous year for data restoration in 2005, highlighted by the $10 million project we completed in the third quarter, our customers are telling us that there is less demand for these projects at the time.

Now let's turn to slide 9.

As you've heard from Richard, while our field operations are running well, our overhead investments ran ahead of forecast in the first quarter of 2006, up 120 basis points.

Much of this increase was expected and embedded in our first quarter guidance.

We had planned our major customer facing and sales delivery organizational meetings, and we knew our acquisitions would increase overhead costs.

Again, as Richard indicated, what we did not see clearly was the near-term aggregate impact of all of our investment initiatives.

The increase in overhead year-over-year includes many puts and takes but is driven by 3 main areas, acquisition impact, customer-facing investments, and the North American reorganization.

What you see here on the slide is the impact that the main investment drivers have on the components of our overhead expenses in our P&L.

First is our LiveVault acquisition, which drove a 50 basis point increase in overheard, impacting all functional areas.

LiveVault, while helping out on the gross margin line, is a higher overhead business relative to our consolidated cost structure.

That being said, LiveVault's impact on our first quarter overhead was exacerbated by integration costs.

And we expect their contribution to overall margins to improve over time.

As Richard pointed out, our customer facing investments are really driven by 2 major items, the shift in the mix of the North American selling resources and the growth in our digital sales force.

In North America, the growth in headcount is below that of revenue growth, but the shift to higher end resources is driving a one-time increase in the level of spending due to the higher costs correct and the additional support required.

The payback for this shift will come in the form of higher revenue and increased efficiency.

To put a fine point on this, penetrating and cross-selling our largest accounts is central to our strategy and our experience has shown that these accounts grow much faster as a result.

In our Digital segment, a business that saw 27% internal growth and 40% storage internal growth, selling costs as a percentage of revenue were much higher than the Company as a whole.

This is natural as it is a faster growing business.

Additionally, we are building out our digital sales force in Europe and made significant progress on this front in the first quarter.

We expect these investments to continue to drive strong digital growth.

Finally, the North American reorganization has higher management costs in the short-term.

The build-out of our executive teams and infrastructure is designed to drive higher margins in support the larger Company we are building.

For example, we are making investments in logistics management that will drive transportation cost savings.

Further in the first quarter, we held 2 major meetings, costing about $3 million to help align our customer facing and service delivery organizations to our new country model.

These costs increased overhead by approximately 20 basis points, spread over the major components of overhead.

Let's turn to slide 10 and take a look at the new guidance.

First, we are raising our revenue guidance for the year and now expect we will report revenues of between $2.27 and $2.32 billion.

Embedded in our internal growth guidance is storage internal growth of 8% to 10%.

We are biased toward 10% so we are raising the bottom end of our range.

And accordingly we are also moving our total growth range up.

Keep in mind that we have a difficult comp in the third quarter due to the $10 million data restoration project we completed last year that won't be repeated this year.

Today we are lowering guidance our OIBDA for the year.

There is a $17.5 million decrease in OIBDA from the midpoint of our old guidance to the midpoint of our new guidance. $7 million of that decrease is due to the reduction in contribution expected from our digital service segment that Richard outlined earlier.

And the balance results from the full year impact of the increased overhead run rate.

We are refining CapEx guidance to a range of $320 to $360 million.

As a reminder, included in our capital forecast for the year is $50 to $60 million of opportunity driven building purchases.

Slide 11 looks at free cash flow before acquisitions for the first quarter.

As always, free cash flow is best evaluated on a full-year basis as the timing of normal periodic event can skew interim period results.

Here you can see that free cash flow before acquisitions and investments for Q1 2006 is a negative $15 million.

The first quarter is historically the weakest cash flow quarter of the year due primarily to the timing of certain large cash payments, most notably the annual component of our incentive compensation plans.

The major drivers of the cash flow in this quarter were the increased consumption of working capital and higher cash paid for CapEx.

The increased consumption of working capital was the result of approximately $12 million more of incentive compensation paid in Q1 2006 as compared to 2005 and more than $4 million of integration expenses related to the LiveVault acquisition.

In the first quarter, we incurred $52 million of CapEx including $29 million for storage systems in our core businesses, $15 million for IT and digital services, and $3 million for real estate.

The cash flow statement shows $74 million, which includes an additional $22 million paid for capital work done or assets acquired at the end of last year but paid for in 2006.

We are increasing our CapEx guidance modestly, primarily due to the CapEx required to support the higher levels of storage revenue growth we are seeing.

Our traditional CapEx slide is also included in the appendix for your reference.

Before opening the phone lines for questions, I would like to remind everyone of a few things.

We have a solid business, and our fundamentals remain strong.

Our revenue is robust.

Those 2 factors drive us to invest.

We temporarily lost some visibility in the time phasing of those investments because of the North American reorganization.

But that's largely behind us.

We feel great about our business, and our ability to execute it against the opportunity in front of us.

Thank you.

We will now open the phones to take your questions.

Operator, if you'll go ahead and queue up the questions.

[OPERATOR INSTRUCTIONS]

Your first question comes from the line of [Douglas Pratt] with Galleon Group.

Please proceed.

Thanks very much.

Can you, didn't expect to be on that quickly.

Didn't have my questions right.

Can you talk a little bit about the revenue impact of the acquisitions?

In other words you talked about how it boosted expenses.

And I believe you commented that there is some foreign exchange.

Just to give us a sense, what's the core revenue growth that you back out of acquisitions and back out FX?

Thank you.

While we are getting specifics on that, this is John, I would remind you that our internal growth calculus, by its very nature, that excludes any acquisition activity or any effect of foreign exchange rate fluctuations.

Now having said that, foreign exchange rate fluctuation cost us about a point in reported revenue growth.

Or said differently, if our FX rates in this first quarter were the same as the first quarter of last year, we would have reported about $5.5 million of U.S. additional revenue.

Okay, maybe then the simple thing is what were the amount of revenues that added through the 2 acquisitions done in the fourth quarter?

That'll at least give us a sense of how much was acquired.

About $18 million, or it represented about 400 basis points of revenue growth, a little under 400 basis points of revenue growth.

Okay, so as a ballpark we could subtract 18, add 5.5 back and that kind of gives us a core number?

Yes, more or less.

Okay, great.

Thank you.

Sure.

Operator, you have the next question?

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

Please proceed.

Hi, gentlemen.

About the reorganization going to the relationship model, just remind us how long this has been going on for?

I remember we had some expenses last quarter as well, fourth quarter.

So how long has it been underway?

And if you made the analogy to this business is big as Pierce Leahy's reorg, how are we going to get all settled in so quickly?

Well first is you're mixing apples and oranges, so I'm going to parse it apart for you a little bit.

When you talk about a relationship model, you're probably speaking more towards what I said was the change we made in North American sales.

If you go back, you realize we created I think about 3 or 4 years ago, we started to segment out our market and our sales force structure approach to it.

And we created our enterprise group and so forth.

And we did some experiments.

In fact a couple of investor days ago we shared with you the results of experiments.

And the net of it is our enterprise accounts, for instance, last year grew 22%.

And so what we chose to do was is we if we took a finer look at our sales dollar and headcount resources.

What we are doing is we're moving resources up market.

That was something you do because you only get to change your sales force once a year.

You don't change them midstream.

It was clear to us that it was worth doing so we went ahead and did that.

And that is where you are seeing not all but a substantial portion of the overhead ramp because the upped markets sales force per person as we said, our actual headcount did not rise that much at all.

It was substantially behind revenue.

But the costs at that upper end of the market per person compensation cost higher.

And there is an higher related infrastructure costs.

Now the other piece of the reorg, and by the way that was plenty of work, don't get me wrong.

A lot of work, a lot of work in comp plans.

A lot of work of interviewing people, moving people around in their roles and so forth in training and getting ready.

The other reorg though was to take our box tape and shred business, which on a local basis is operating in many cases as 3 separate end market local businesses and put them together.

We started planning a year ago.

We had planning teams.

We worked through a variety of things.

We worked very hard to move a lot of people around.

And you don't just move people around in the field.

And I don't mean physically moving, although there was some of that is going on.

There was some relocation costs and all.

It's you're moving within your accounting structures.

So that what we created was a market based structure that by city market now they're all in one business unit with one leadership group and one local overhead group.

So you integrated a lot of people on your P&L and move them around.

We also did the same thing though between our corporate and our divisional staffs.

Whereas we had a, if you think about a corporate staff that when we do segment reporting unfortunately gets rolled up in North American but really does some work for the rest of the world.

So that makes North American margins look a little odd because we continue to grow corporate staff in Boston primarily in places like that.

And they are spread; their work is spread on a more global basis.

But we moved people who like in HR functions who were in corporate functions.

They are part of North America.

They support North America.

They do some support globally.

We had to combine and extract and move around some of these staff functions.

We had separate HR functions in our OSTP business, separate functions in our box business, et cetera, et cetera, as well as corporate.

Same thing, accounting, we actually had separate accounting departments.

We've combined.

We combined and physically relocated our transactional accounting shop, the people who really do the majority of the day-to-day work from Boston to Collinsville, put them into one.

I mean the list goes on and on and on, a lot of work.

Okay?

By the way, at the same time, we took our digital business, which if you remember was a combination of start ups that we had done within Iron Mountain in our digital archive as well as the connected acquisitions, and then the LiveVault acquisition beginning of the year, and took all of those products as well as the intellectual property management group and put them into one additional business unit.

Net, net, net, thousands of people moved around in accounting structures.

Things, a lot of hard work, a lot of planning.

During the planning we realized that we would have problems of visibility with overhead.

We just did not realize the impact.

We focused dramatically and very successfully of maintaining visibility at the margin level so that people that are day-to-day managing the business had the ability to do so.

They did.

They performed well.

It worked well.

On the other hand, the amount of work and what it took to do this, as I said in my comment, the budget process was finished later than normal.

The uploading embedding, I mean you've got lots of systems.

You have to get your accounting system and link with your HR systems.

And you have to go body by body by body and make sure they are in the right accounts.

And then what happens is you really don't have the a comparability year-over-year.

And that is at the overhead level.

We do have it at the margin level.

We were able to maintain that at the cost of goods and margin level.

And that's where we frankly lost visibility because at the same time as I said we were pouring on the coals.

But how do we know we have visibility now?

Well first is we don't have absolutely crystal clear visibility.

If you're going to have good year-over-year, it takes a year to get there.

But second is now that our finance team and our teams are not focused on getting the budget done, what we're focused on is peeling everything apart.

Okay?

And looking, getting better comparable data, which is why we are able to talk to you today about what's going on.

And then last is we're not reorganizing the business again.

I do not see that in my lifetime.

As I've said many times I plan to live a long time.

And Andrew I would add that now the we have a quarter under our belts, we do have the ability to look at consecutive quarter data.

At a high level.

Okay, fair enough.

Thank you so much.

And then of course last is, now that we have gotten the work behind us, we are into forecasting.

And look it's forecasting exercise is what has caused us to pull our head up and say we need to bring our guidance down.

As soon as we realized where we were, that is what we are telling you.

Right.

That sounds sensible.

Thank you.

Your next question comes from the line of Chris Gutek with Morgan Stanley.

Please proceed.

Thanks.

Good morning, guys.

Chris Gutek with Morgan Stanley.

A couple of questions, first John I guess you talked about the acquisitions.

Some of the bigger acquisition last couple of quarters causing higher integration costs than you might have expected.

Putting that issue aside, how are those larger acquisitions like Pickfords and FDS performing, number one?

And number 2 I think you said there were 3 new deals or several new deals so far this year.

How does that contribute to the increase in revenue guidance versus changes in your organic growth assumptions this year?

While John answers your second part or pulls the data up, I'll answer your first one.

We really were talking about 4 deals closed late in the year.

One of them was a deal in Spain.

That business is running slightly behind our projections.

But mostly, not mostly, totally related to some project work expected that is delayed coming in.

But we expect it will come in.

An acquisition in France, which is running ahead of plans, the secure shredding acquisitions in the UK, and there were a couple of them.

They were own planned through Q1.

And I remind you that our European operations have a staggered or a lag reporting, their Q1 is ahead of ours.

And so they were on plan through their Q1 or through January and actually now are actually running ahead of plan, but that's not through our numbers.

That'll come through next quarter.

And then the Australian acquisition of Pickfords is running on plan accept that in our plan was some real estate rationalization.

That is, we are moving out of some buildings into some new buildings, which were part of the deal model.

That is we knew it coming in the deal.

What is different is we are doing them faster than we had originally thought, and they have paybacks.

So that business will be on plan for the year or and possibly even up for the year.

And then the last one is LiveVault, which closed in December, is behind plan, primarily.

There is some integration costs as I said.

But primarily because they have a license product that was brand new to the market, actually launched to the market just a few months before we stepped in.

And we have pulled it back.

Not, we haven't taken it off the market, but we pulled it back and decreased our outlook for that.

And that's only because they rushed it to market.

And we've got some QA we've got to do on it before we.

I mean we're selling it and it works.

Don't get me wrong.

And I don't want to scare customers.

But what we found was customers were driving the product to do more than the original was designed.

They were trying to do more data than it could.

And it can do that, but we've got to do some work on it so it does it smoothly.

So we pulled it back a little bit and put it back in the lab or effectively limited the market opportunity we'd let them sell.

And we're redoing it.

And it will be back out in a few months.

John?

Yes, and the new deals that we announced are really only a couple of small deals, which would contribute less than $8 million to the year.

Okay, and John a quick follow-up on your balance sheet.

I guess for 2 quarters in a row the percent of your significant debt balance that it's at variable rates has increased.

And it's now 23% of the total debt balance.

Is that bet that's the Fed is almost done raising rates?

Or is it a little bit of a blip?

Or what is going on there?

I'll let Jeff Lawrence, our Treasurer who manages that take this.

Hi, Chris.

We have a target range, which is not it a rock-solid range but one in between 80 to 85% fixed.

We were actually a bit over hedged or over fixed coming into this.

And we are now about into our range.

Having said that, our model and projections for the year have assumed that there will be a 25 to 50 bp increase in LIBOR over the balance of the year.

Great.

Thanks, guys.

Your next question comes from the line of Henry Naah with Lehman Brothers.

Please proceed.

Hi, guys, 2 questions if I many.

First one for Richard, I was wondering, it seems like you go through these reorganizations and restructurings or it has occurred about every 2 years over the last 5 years or so?

Just wondering, does this reorganization this time feel any different than what you guys were doing in '04 where you're trying to revamp the sales force to better focus on growth and opportunity?

Well for first is I do want to correct your statement.

We have never reorganized in my 25 years the operational side of the business, which is what we're really speaking of in the North American reorganization.

What we did in the sales force was frankly an expansion of what you're just talking about a couple of years ago.

As I said, we did an experiment.

We put about 10 or 15 people at the upper end of the market.

Went after a small handful of customers.

Learned and tested the premise that our large customers would like to buy more from us through the cross selling premise or the portfolio of customers that we built up.

Proved out that premise.

And really started to do ROI analysis on our sales expense cause our strategy is to drive increased efficiency in our sales force.

And we've spoken to that before, and we are basically following that.

We are going to try to our drive revenue growth for a while without just marching heads up in line.

That is why the North American heads are down, but we have had to go through this one-time reshuffling.

And so it's just a continuation of that.

And Henry, we in the past we have had major acquisition integrations, Pierce and Hays.

Those are very different than realigning the business around the customers to drive and maximize relationship value.

Although they both have about the same amount of work.

But they have different impacts.

Okay, great.

Thanks for that.

And question for John if I may.

Growth margins tick down here to 53.5%.

Saw strong growth margins last year in North at 54% throughout the year.

Wondering if you're thinking that these are going to tick back up north of 54% this year?

Yes, I think we are, well first of all the first quarter sees some seasonality principally in the form of higher energy costs, which can cost as the better part of 60, 70 basis points.

And obviously over the course of the year, some of our efficiency initiatives will kick in and acquisitions mature and come out of their integration stage.

I think embedded in our guidance is the likelihood of gross margins roughly flat to last year in the 55% range.

Great.

Thanks, guys.

Your next question comes from the line of Jeff Bork with Robert W. Baird.

First off, thank you for the detail on the overhead variance.

I'd say very helpful and we appreciate the candor.

Just a couple of further questions on it though.

The one thing I am having trouble reconciling is you made reference to most of the source of the variants being known going into the quarter.

And yet you took the OIBDA guidance down by $17.5 million, which if I annualize the headwind in the first quarter, would be more than half.

So just, I am trying to get a sense for what why the OIBDA was taken down so much, especially when some of the things should fade like with the reorg being mostly done now?

Well, first of all, contributing to the downward guidance in OIBDA is the expectation of $7 million less in contribution from the digital business.

And some of the issues associated with the increased overhead will be persistent.

We're not going to pull back our customer facing organization.

We like its efficiency and yield and its results and whatnot.

The other issue point I would make is that we decided to add some overhead into our North American field organization.

And I think what occurred is we just ramped a little faster than was embedded in our guidance.

So I think while some expenses fade, when you net it all out that is where our guidance comes out.

Okay, that's helpful.

And then second question, the North American box business, you talked about the acceleration on the storage side there.

Can you give us a little bit more insight into the price volume split?

And then as well I think you said the box services growth rate was tracking storage.

Can you give us some numbers around that?

Yes, the 8 in box storage is roughly 7 volume, which has been relatively stable for a long time and about a point a price.

In terms of the core services directly related to boxes, I am speaking as slowly as possible because there is an iChart someone's looking at.

I think we're going to find it be very closely in line.

If that's at all different, I will.

It was a little over 7, so 7 versus an 8.

Great, and then one last quick question, just a clarification.

Richard, you said that the enterprise accounts grew 22% last year.

Can you just clarify, are you saying that the number of accounts?

No, no.

I am talking about revenue.

Let me explain a little deeper.

When we say enterprise accounts, what we're talking about is a name set of largest customers in the world where we have wrapped around them with a much higher staffing model, not only on the sales side but on the account support side and so forth.

With the view that they have a strong interest in buying deeper into our value proposition for protecting and storing information on a broader scale.

Meaning that they are more interested in buying digital services, physical services, more penetration, more shredding, more everything.

And so we wrap around them to help them do that, and that is a name set of accounts.

So the named group of account basically we were limited on our ability to expand how many of those accounts we can help them with.

And so we'd analyzed and figured out a small group of accounts.

We had a low penetration of revenue, in other words great opportunity.

But if you can't put that level of resources around, you to just can't get there.

And we had sort of saturated with the level of resources we put in, just a very small handful of accounts.

So it's not about account growth.

It's about revenue growth on a fixed number of accounts.

And then what we are doing now is putting more as I said moving feet on the street up market.

And putting more focus on more of those accounts because the real problem we have is we have a large number of very large accounts that would like to buy into this.

We do not have the people to put in front of them fast enough.

And so what we are doing is continuing that process.

And so long as it's working, we're going to keep doing it.

Okay.

That's helpful.

Thank you guys.

Your next question comes from the line of Michel Morin with Merrill Lynch.

Please proceed.

Yes, good morning, a couple of questions.

The first you mentioned the internal growth rate in digital.

I think that was 27%.

I was wondering what the total growth rate was for that area and what kind of run rate you are on right now and how profitability is tracking?

It is almost the same number because they only have 1 month of LIBOR, I believe.

In fact it's not even factored in.

So the internal growth rate and total is the same thing.

And profitability, we're talking about the OIBDA level it's above breakeven, but not a lot at the OIBDA levels.

Okay.

And in terms of the volume growth that you're seeing, are you finding that you're gaining share?

It seems that you have been recently relatively at least to your largest competitor globally.

Have you seen situations where you might even be stealing the existing number 2 player given that they've been undergoing their own kind of restructuring?

You're talking about in the physical businesses?

Right.

Looks, it's a big market, and I am not sure I can account for every customer where it comes from.

What's going on is customers particularly the bigger, broader, global customers, are consolidating vendors.

They want fewer vendors, fewer relationships, broader portfolio because it reduces their cost and reduces their complexity and reduces their risk.

Because in the final analysis, the drive cost down and compliance up, they have to do that.

It is about consistency.

And so I wouldn't know if there's a share swap going on or anything else.

There is a consolidation trend among customers.

And we are getting more than our fair share of that now.And I think that goes both ways, by the way.

And that includes people actually packing their boxes and moving them over?

No, that and there are other ways to do it that I will not get into details on the phone.

But, yes, some of that and some of it is go forward.

There's just a lot of strategies of how to do it.

But like I say it can go both ways.

Sounds good.

Thank you.

Your next question comes from the line of Edward Atorino with Benchmark.

Please proceed.

Could you talk about the government market size?

How hard it is to get the stuff, margins, pricing, all of that stuff?

It's so new I do not know if I can answer too much except that it's bigger than all outdoors.

Bigger than a breadbox?

Absolutely.

And what, just to give you a sense is, there were historically rules that required some pretty odd behavior.

But basically said if you're going to store records outside of your own control in effect, you had to put them with the National Archives.

And what that really meant is it is an enormous amount of records for the federal government sitting around in warehouses.

Not inside the agency, but not in a record center.

And so there's a big amount of records there.

And so they have changed the rule to say that a commercial record center effectively can be qualified to store and go after the business.

That's a rule that's been 5 plus years in the making, and it makes a lot of sense.

And what the government was doing had some logic to it because the National Archives' charter is to protect the legacy of all the information in the legacy of us, of our country.

But the way I think the process will come down is instead of our agencies going out and renting warehouses and running their own.

And in many cases not going a very good job, they will be able to use commercial record centers after which before things are destroyed they'll be sorted out and maybe if they're permanent they might want to go onto to the National Archives after 10 or 15 years and stored there.

So it's ability in a lot of cases to put what I call a middle tier into the infrastructure.

And it's a huge market.

The National Archives probably got as many or more boxes than we do already.

The government represents 15% of GDP and less than 2% of our revenue, most of which is state and local.

But I want to be cautious here.

It takes a lot of time.

That was my next question.

It takes a lot of time.

And so this is a long-term investment on the beltway.

And that's why we got it started because the opportunity opened up, and we have done a little work down there to know that it is a different game.

How you sell, how you approach it, contract management.

It takes more overhead frankly to sell into it.

But there is tremendous opportunity there.

And we've already had some successes.

We think we will see more.

More like an '07 event?

Well, unless, hopefully, nothing is an event in our area, in our business.

But, yes, we've already closed some business this year.

But who knows when it'll be big enough to talk much about except as an expense.

Okay.

Thanks.

Your next question comes from the line of Franco Turrinelli with William Blair & Company.

Please proceed.

Hey, John.

Hey, Richard.

Two questions, the first is maybe give us a little bit of an update on the shredding business and the competitive environment there.

It seems to be something that less people are talking about.

And I wondered if you could just give us an update on what you're seeing?

Shredding business still doing well.

Internal growth rates are strong.

We've got a business that's running about $160 million U.S. worldwide.

We are the, it is hard to know who is exactly the largest player in the U.S.

But so on an integrated bases we're pretty sure we are based upon tonnage and a few other things we've seen.

And we are, we know we are the largest in the United Kingdom now, based upon an existing business we had and a couple of acquisitions.

The competitive landscape remains competitive.

It has always been a competitive business.

It remains a competitive business.

But the market drivers are still strong, information privacy, et cetera, et cetera is still a driver out there.

I would add 2 things.

First of all, many of you are calling from the New York area.

We just opened up a state of the art world-class very large scale shredding operation in Jersey City.

And we encourage you to go take a look at that and let us know.

And the important element of it is besides the adjective to very large and world-class is we actually, one of the things we've learned in the shredding business is we've said this many times.

When you buy them, you oftentimes replace the plate and equipment because of the under investment that the entrepreneurs do in this business and so forth.

And so we spent some money in engineering and drawing and going back to the drawing board.

This is a prototype for us we think early results are fantastic.

We've gone out and taken an engineering approach to the problem.

This baby will hum.

And this is another example of how some of our investment dollars are shifting.

This thing can do up to 100 tons per day.

That is an enormous amount of paper.

This is a CapEx kind of event, not an acquisition kind of event.

And we're going to do some more of those.

We've got some more being built or on the drawing boards and coming out of the ground over the next couple of 3 years.

And it'll drive margins for us in a capacity.

We are still buying businesses in this space, but we are balanced between build and buy.

Okay, Richard, the other question and this is a big picture one.

If you cast your mind back say probably 2 or 3 years ago, a lot of the conversation around margins was when the amount exceed 30, 31% margins.

And a lot has happened since that time in terms of new businesses, in terms of business mix, in terms of reorganization.

Update us on your longer-term thought process for margins and related to the experience in this quarter and the comment that John made earlier about some of these expenses not going away.

I'm assuming that we need the business to grow into a current infrastructure rather than expenses declining.

So give us a longer-term, forward-looking update on where you think margins could or should be.

Well, first is margins; we've tried to say lately it's not our Holy Grail.

Let me explain what that means.

We do not manage quarter-to-quarter margins.

We do try to manage, and we did it, but we as we said with the low end here we did it.

That is we do try to hit our guidance with respect to absolute dollars.

In this case, we are above our absolute dollar in revenue and at the very bottom in contribution.

But we do not manage day-to-day to margins.

What we are doing is investing to increase and enhance long-term margins balanced by growth.

We are biased for growth.

We, if you remember going back a few years, when we talked about growing margins to 30%, in that case we were pretty much a physical business.

Box and tape pretty much, didn't even have that much shredding.

And those margins continued to rise, and they have done well through scale, through growth and revenue growth and scale and so forth.

There's more margin left in those businesses but it takes investment and that's where some of the money.

In fact a good part of the money we are talking about that not only when we did the North American reorg, we put some more management in that structure and some more staff, both in field as well as in things like.

We're actually building out an operations engineering group.

We see the opportunity to reengineer workflow and drive costs down.

We built out, and it sounds simple, but we have a substantial transportation business that we never thought about as a business.

We thought about it as just a revenue stream.

We did not manage it as a business should thought about it.

It's just revenue stream.

And frankly didn't manage it as a business.

So we are adding field management as well as staff management.

We have gone out and hired some real top-notch professionals here.

And they're almost laughing at us as to how bad we are in managing.

And it's a result of their basically saying the margin they think the can pull out is quite good.

And by the way, we've done some prototype work, which we're pretty good at doing this.

And we pulled some serious money out of a city or 2 already.

And we are going to start to see some of that coming in towards the end of the year and on into next year as they go around city-by-city.

They've got a lot of cities to go to and reengineer how we think and how we operate.

At the same time we're investing more in our transportation side of the business to make it a more professional organization.

So investing in our people.

We're investing in more technology.

Inadvertent disclosure, that is lost tapes and all those kind of issues are going to be around.

We've got 5, 9 who are liability.

And I checked this this morning and we're up.

But getting it over to 6, 9 is going to be hard.

But we've put more money where if you're not dealing with us, there isn't nobody going to be having the quality what we're building and that sort of thing.

So, those are just some flavor of those sort of things.

Net, net when you look out I think that the physical business is we'll achieve 30.

And we'll achieve it again.

But the overall Company margins, I can't tell you a target at the moment because it's a mix issue.

It depends upon growth rate of different products and different parts of the world.

But we do believe margins will rise, that I can tell you.

It will not march up.

It will not march of every quarter, just as it obviously didn't here.

But we are looking for the long haul for a level of continuous improvement.

And look I want to reinforce one other thing here.

If we hadn't, I mean look this team is in the field they're pretty pumped because they are doing a good job.

But sitting around this office right now, we are pretty down because if we had predicted this, we would have been so arrogant, pounding the table how well this business is running, how well we're doing.

You couldn't stand to be in the room with us.

But we're down because we blew it.

We blew it.

We didn't predict it.

And that bugs the crap out of us.

And you need to know that.

All right.

Thanks, Richard.

We will take one more question.

Cause we've actually run over our noon stop time that we've said before.

Your next question comes from the line of [Peter Dirillio] with Citigroup.

Please proceed.

I'm actually going to correct that one.

It's [Pete Dorillo].

But that's close.

Two questions quickly, on the last question just now asked over the long term, are we realizing that the to find out managed quarter-to-quarter for margin.

But at some point out there, you will obviously manage for margin, in 2 years, 3 years, 4 years.

Is it, should we eventually settle in at a 28, 29 type of set range?

Or might we just stay where we are now for the next 3 to 5 years?

As we said, we know they are going to go up.

We just do not know how high.

So we're settling in right where they are now.

I think that over the long haul would not be a good way to think about it.

What are the mechanisms you do at some point, 2, 3, 4 years out that eventually bring in margins up higher?

Well we're already investing in those mechanisms now.

Just as this long soliloquy I went through of transportation everything else.

That will help us drive margins.

And some of the cost we put in, restructuring ourselves.

And I want to be careful.

We didn't restructure ourselves.

We shifted a mix of people.

We may keep doing that over time, but what will happen is the accelerated growth rate as we do that will wash over some of that.

You might get some early stage, one quarter kind of effect.

But we are investing in margin now, and you will see them go up.

The presumption of that our consolidated margin percentage will be the overriding goal of the Company at some future point is not ...

That's what we're basically trying to say.

... is flawed.

That is to say that each of our businesses will be optimized to achieve the margins they are capable of to maximize return on capital.

What our mix of businesses will be 5 years for now is something that you can predict but not predict with perfect accuracy.

If we find a 10% margin business that has no capital and is records related, we can push it through our sales force to our customers, and it drags down weighted average margin, so be it.

Return on capital and value creation is what drives us.

Okay.

So thank you.

In closing, I've got a few comments.

We've got a great Company and a great market.

We are coming off a strong year in 2005 and we're outpacing our expected growth rate to start '06.

I've shown you over the last decade that this Company will deliver.

And I'm more confident than ever that we will continue to deliver.

I realize I surprised you today and I'm sorry.

But I want you to know 2 things.

This is a great business, and we are making it a better business.

So we thank you for your continued support.

We will be at out at some investor conferences soon.

In fact starting next week I think, next Tuesday, the R.W.

Baird conference in Chicago.

I look forward to talking to all of you about your Company.

Have a good day.

Thank you for your participation in today's conference.

This concludes the presentation.

You may now disconnect.

Thank you, and have a good day.