鐵山公司 (IRM) 2006 Q2 法說會逐字稿

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Good day, ladies and gentlemen.

Welcome to the Q2 2006 Iron Mountain Incorporated conference call.

[ OPERATOR INSTRUCTIONS ]

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

Please proceed, sir.

Thank you.

Welcome, everyone, to our second quarter 2006 earnings conference call.

After my announcements this morning, Richard will give his state of the Company remarks.

He will then turn the call over to John for the financial review, followed by Q&A and brief closing remarks.

At this point, I would like to thank everyone who came to see us as we presented in several conferences in New York and Chicago last month.

We had great turnouts and as always, we appreciate your support.

Hopefully by now, you have all seen our announcement that we will be hosting our ninth annual investor day in New York City on Thursday, October 5.

Information about registration will be available on our website in early August.

Watch out for that.

We look forward to seeing you all in October.

For our custom, we have a user-controlled slide presentation on the investor relations page of our website at www.ironmountain.com.

Let me refer to you now to slide two.

Today's earnings call and slide 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 and free cash flow before acquisition and investments are metrics we speak to frequently and ones we believe to be important in evaluating our overall financial performance.

We provide additional information and the reconciliations of these non-GAAP measures to be appropriate GAAP measures as required by Reg G at the investor relations page of our website, as well as in today's press release.

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

Good morning and thank you, everybody, for joining us.

Q2 as you saw from our press release this morning was a solid quarter both in revenue and OIBDA as we slightly exceeded our targets.

The revenue dynamics are, frankly, positive, and we'll continue to do that, our overhead spending is fine as we projected in the same pattern as we talked about in Q1.

We continue our agenda of expanding internationally.

We continue our agenda of strengthening our business and our management team; however, during the quarter, we experienced two significant incidents related to fires, which I will speak to in a second, and we're working very hard to make sure that we address our customer needs and make sure we protect their records and so forth.

First, let me talk to you a little bit about the financial results and how the business is running.

Operationally, as I have said before for the last few quarters, the business is running well.

Our organization is doing a good job.

The market is coming our way.

Our sales force is producing.

Q2 revenue growth was solid and our performance was above our expectations slightly.

Internal growth did 9% and -- driven by storage revenue growth -- internal growth at 11% and as you saw, total growth of about 14%.

OIBDA obviously lagged that with the same trends of overhead spending primarily related to customer facing investments as we spoke of last quarter, which is, in fact, paying off and driving this strong revenue performance.

All of our businesses across the board are providing -- are performing well and growing well.

The North American physical business growth trends are actually up slightly.

Our shredding business -- our emerging businesses such as shredding and digital growth trends continue to remain strong and our international business, particularly in Europe, growth trends are in the same pattern as they have been in the past.

Our sales force is performing well and, in fact, running above plan and have strong pipelines.

Our enterprise accounts are growing well and, in fact, we are seeing and closing significant new business, some of which is not even begun to show up at the front door, which will continue to bode well for our revenues for the balance of this year and into next year.

We expect.

As I said, international expansion follows our agenda.

Our goal is to be where customers need us in footprint and technology.

We entered a joint venture during the quarter in India, putting us in four cities.

We will do some internal expansion on top of that in India to other cities as we try to build a true national platform in that country.

We see tremendous growth opportunities there.

We like the partners that we invested with and we think that this will follow the pattern of some of our other international joint ventures and give us significant growth and opportunity, plus, the opportunity to support customer needs in that emerging part of the world.

We also did a nice line expansion in Australia on the acquisition of DigiGuard.

That's an off-site data protection business.

As you remember, we just entered the Australian and New Zealand markets late last year and the company that we acquired there was primarily in the record storage, paper storage business, so we have now added to that product line with the DigiGuard acquisition in that part of the world.

On top of those expansions, another part of the agenda, we've spoken to you before is strengthen our team and we have made significant progress in that space.

We have a new President of Europe which we've talked to you before about being in search.

Mark Duale who recently joined us.

He's an experienced executive with a strong educational background, has run businesses both in Europe as well as in Asia.

He's been in the logistics business, in senior positions with DHL as well as in information business with Reuters.

So he comes with a good, broad background, a strong education, and we think he's a real international, global executive that will add to our team.

We also welcome recently Linda Rossetti, the new Executive Vice President of Human Resources;

Linda comes with both a strong business career accomplishment as well as strong education.

We're putting even more focus on the human resource group as a strategic part of our business with 17,000 employees around the world, so we chose an executive that has strong business reach and the ability to think at a high strategic level as we try to make sure we build upon our employee base and build for the future.

We have also told you we are in a CFO search and that continues but John Kenny remains in the role and will do so until we find the right person.

We're in no hurry per say because we're well-served there but the search will continue until we get to that point.

As I said, the business is running well.

We're following our agenda and I couldn't be happier about how on a routine basis they're operating; however, we have had and been hit by two unrelated, but nevertheless, difficult instances.

We had a fire in one of our facilities in Ottawa on July 11.

This is a three-story building, a building protected by sprinkler systems, alarms and protection systems.

They apparently worked well.

We did suffer some lost records but relatively few.

Records that list about 0.04% but nonetheless, there were boxes damaged through water.

Those are being recovered, though; they're being frozen and freeze dried and recovered.

A lot of work on behalf of our employees to do this work if only to clean it out and freeze the boxes and do this sort of thing to make sure we recover them on behalf of our customers.

In this instant, we're certain we know the point of origin.

It was a contractor working on our roof, our expectations as we look at the investigations.

But our investigation is ongoing and we have learned of some actions that we think we can take in the future that will help keep this from happening.

So, we're going to change our processes just to add more security during any kind of construction project or any kind of repair.

In this case it was a roof repair in which they just made a mistake.

We also, though -- the next day at 11:30 p.m.

London time on the 12th of July, we suffered a major fire in a large facility.

This is the facility that came to us through the Hays acquisition a few years ago, a modern, segmented, protected record center.

One in which we had eight employees operating on a night shift, as well as a third-party security guard in a well-secured area.

The fire brigade responded as expected.

The fire protection systems, although early signs say they kicked in and started working, for whatever reason yet to be determined, the building burned to the ground and was effectively a total loss.

So, we're doing a significant postmortem investigation.

We have to work behind the London fire brigade because they and the London police, obviously, are doing an investigation but we have engaged not only teams from the U.S. both in terms of experts in the fields of investigation, but as well as forensics and as well as fire protection, as well as experts locally.

We expect that investigation to take some time because, as I said, we have to work behind the authorities, not ahead of the authorities and work with them, and we're cooperating in all ways that we can.

Until we understand the source of what caused it, we are reacting by adding security to all of our operations in that part of the world, just to make sure, although we have no specific evidence of any other kind that this was an instant -- or a threat that would be repeated.

It doesn't matter.

We're behaving and acting in what I'd call a paranoid manner because until you know, that's the way we're behaving.

We continue to focus on ways to make sure we can protect our customers' records.

These were tough incidents for our customers, tough incidents for our employees.

They performed well and thankfully no one got hurt.

And that's the first thing you worry about in these circumstances.

But we did lose a significant number of records.

So, we're pretty busy on that front.

The organization is mobilized and make sure that we do the best we can after we -- after the dust settles a bit.

We will go through the formal analysis to make sure that if there is anything we could have done better, then we will do that.

It's too early to tell at this stage.

But, we're committed to protecting our information and protecting our business and we will learn from the instances going forth.

So, as a summary, as I said, operationally I couldn't be happier about how the business is operating.

The revenues are working and investments are working.

The business is doing well.

I'm not pleased with these incidents and we will not rest until we get them figured out.

Let me now, at this stage, turn it over to John Kenny who will review the operational results.

Thank you, Richard.

Slide three is my agenda for this morning and after reviewing the major P&L line-items, I will talk more specifically about our revenue growth.

Next, I'll walk you through a review of CapEx and cash flow, followed by the discussion of our debt portfolio.

Finally, I'll give you our guidance for Q3 and the balance for 2006.

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

Second quarter of 2006, Iron Mountain demonstrated solid operating performance.

Our revenue and field operations were particularly strong and we saw the continuation of the overhead investments we discussed in detail on our first quarter earnings call.

Here are the key messages.

Business, the business performed well and as expected in the quarter.

Our revenue performance remains strong across geographies and product lines driven by higher storage internal growth in the North American physical businesses.

Operationally, we also had a good quarter as underlying gross margins increased.

Lastly, our overhead investments continue this plan in the quarter.

These are driven primarily by higher investments in our customer facing organization, the impact of the LiveVault acquisition, and investments designed to support a larger enterprise and drive future margin expansion.

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

Slide five compares results for this quarter to Q2 2005.

The dynamics at work here are the same as they were in the first quarter.

As we have mentioned, revenue increased $70 million or about 14% to $582 million in Q2 2006 compared to Q2 2005.

The revenue story remains a great story and one that I will expand on in a few moments.

Gross margin at 55.4% was in line with Q2 2005.

Excluding the dilutive impacts of our recent acquisitions, gross margins improved about 50 basis points for the second quarter, compared to the same period last year.

This improvement was driven primarily by increased storage gross margins in the North America paper business, plus improved labor ratios and lower product costs as a percent of revenue in the North American physical businesses.

These increases more than offset higher transportation costs driven by rising fuel costs.

The acquisitions, which we talked about last quarter, are all stand alone in nature and don't benefit meaningfully from any fold in synergies.

These acquisitions are key components of our overall strategy.

For example, they brought us to new geographies such as Australia and New Zealand, they introduced new services to existing geographies such as shredding in the United Kingdom and also document management services in France, Spain, and Brazil.

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.

Further, the shredding businesses in Europe are subscale and have lower gross margins than the enterprise as a whole.

But let me also remind you that this line of business requires less capital than our core storage businesses.

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

Moving down, operating income before depreciation and amortization or OIBDA as we call it, was $154 million or 26.5% of revenues for the second quarter.

As was the case in Q1 and consistent with our plans, our customer facing investments, infrastructure build out and investments designed to support a much larger, much geographically diverse enterprise and to drive future margin accretion all led to 130 basis point increase in overhead spending year-over-year.

Let me get into that a little bit.

First, the LiveVault acquisition drove an increase in overhead which impacted all functional areas; sales and marketing, general and administrative expense and IT.

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

Next, our customers facing investments are driven by two major items.

One, the shift in the North American selling resources and the growth in our digital sales force.

In North America, while the sales headcount is below, running below that of -- the growth in sales headcount is riding below that of revenue growth, the shift to higher-end resources is driving an increase in the level spending to the higher costs per rap and the additional support required.

The paybacks for this shift comes in the form of higher revenue growth and increased efficiency.

As you know, penetrating and cross-selling our largest accounts essential to our strategy and our experience shows that these accounts grow faster than the rest of the portfolio as a whole.

In our digital segment, selling costs as a percent of revenues were much higher than for the Company as a whole.

This is natural as it is a faster-growing, more sales-intensive business.

The digital business saw total revenue growth of approximately 40% in the quarter.

About three-quarters of that growth was generated internally.

Additionally, we're building out our digital sales force in Europe.

The digital business is performing to its revised plan.

We expect these investments in sales to continue to drive strong growth.

One caveat is that remember that last year in the third quarter, we did a very large $10 million data restoration project that is not likely to repeat this year so that represents a difficult comparison in that complementary service line.

Further, as we discussed on a first quarter earnings call, the rapid growth in our digital storage business, which had an internal growth rate of storage of about 40% in the quarter has caused us to increase our IT investments to support this business.

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

The buildout of our executive teams and infrastructures designed to draw higher margins and support the larger Company we're building.

We continue to invest also in logistics management to drive transportation costs savings long-term.

Depreciation at $46 million and amortization of $5 million for the quarter were both in line with expectation.

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

I will spoke to this more in a few moments.

Moving on to slide six, can you see interest is in line with expectations and flat year-over-year.

I will talk more about our debt portfolio and our recent high-yield offering in a few minutes.

In Q2, 2006, we had other income of $7 million or $0.03 per share versus other expense of $5 million or $0.02 per diluted share in Q1 of 2005.

In both periods, the other income or expense is the result of the foreign currency exchange rate fluctuations as we mark our inner Company debt-to-market.

Before moving on, I should also point out that our effective tax rate this quarter was 38.7%, significantly lower than our usual 42%.

This is a one-time reduction caused by a new Texas law changing the way state income tax is calculated for that state.

As a result of this change, we were caused to reverse a deferred tax liability of about $1.7 million net of federal tax benefits.

Again, related to Texas state taxes.

We expect our tax rates to return to historical levels in the third quarter.

Not to move too quickly, but slide seven and eight are the year-to-date versions of the two slides we've just reviewed.

And as I've already mentioned, the second quarter results were a carbon copy of the first quarter, so there is really nothing new to discuss here.

So with that, we should move to slide nine and begin a detailed look at our revenue performance for the quarter.

Our revenue growth remains strong and the growth dynamics that we saw emerging throughout 2005 and the first quarter of 2006 continued into the second quarter.

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's exactly what we saw in the second quarter of 2006 as total revenue grew 14% on the foundation of 9% internal growth.

The key message here is that for the third consecutive quarter, storage internal growth was 10% or better, rounding to 11% in this quarter.

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

As important is the makeup of that 11% internal storage growth rate.

It's being driven by strong internal storage growth in the North American box business.

For the second quarter in a row, the storage revenue internal growth rate for that North American box business exceeded 8%, a level not seen since 2001.

This also marks the seventh consecutive quarter for which that storage growth rate has increased.

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

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

Iron Mountain Europe continues to perform on plan, reporting solid growth rates and our shredding business once again, posted a high teens internal growth rate.

Let's now turn to slide ten, total revenue growth rates.

For the quarter, we reported total revenue growth of 14% as I said.

Internal growth in the quarter was 9%.

In acquisitions, primarily the strategic acquisitions we have already discussed contributed five points to overall growth.

Finally, unfavorable year-over-year foreign currency fluctuations reduced our total revenue growth but by less than 1%.

Moving on to slide 11, you can see that all of our internal growth rates are near or above the top-end of our forecasted ranges.

Storage internal growth has been strong all year and currently rounds up to a number outside of the top-end of our forecasted range.

For the year, we're strongly biased toward the top end of our range.

However, we expect the upcoming quarterly rates to come inside our range as we face tougher comps related to strong North American storage momentum in the second half of 2005, and the increase in digital storage resulting from the large data restoration projects that were completed in Q3 2005.

As for the core services and total internal revenue -- internal growth rates, they're less predictable but again, we're biased to the high end of the ranges.

Our complementary services revenue had another strong quarter growing internally at 9% driven by continued strength in our fulfillment business, improvement in our North American project work and higher growth in our European business.

Offsetting these improvements was a decrease in data restoration projects in our digital business and lower data product sales than the prior year.

We also face a very difficult comp comparison in the third quarter with respect to complementary services.

Since the $10 million data restoration project we completed in Q3 2005 is not expected to repeat this year, internal growth for complementary services will most likely be negative next quarter and, therefore, our total internal growth rate is likely to be flat to slightly down in the second half compared to the first half of 2006.

This is nothing new and something we have been talking about for quite awhile.

That was an extraordinary project.

Let me stop for a moment to remind you that we present our internal growth rates as whole numbers and as such, we're subject to the vagaries of rounding conventions.

Basis point changes in our growth rates can result in whole percentage points moved in the presentation.

It's particularly true this quarter as storage rounded up to 11% and total revenue internally growth rate rounded down to 9%.

Let's now turn to slide 12, capital spending and investments.

So far 2006, we have had capital expenditures totaling $139 million, including $13 million in real estate purchases.

We are currently spending according to our plan and expect that by the end of the year we will be around the top end of our forecasted range in large part because our growth is robust.

The increase investment in the second half of the year will be driven primarily by investments in storage systems to bring on additional capacity and in real estate.

Our real estate spending is comprised of building construction and facility purchases.

The construction component has some seasonality as that activity picks up as weather improves.

Also, many of our planned real estate acquisitions are slated for the back half of the year.

Continuing on, slide 13 looks at our free cash flow for the first half of 2006.

For the first six months of 2006, we have generated $13 million free cash flow before acquisitions.

Our operating cash flow before changes in working capital is up about 9% compared to the same period in 2005.

This is due to a 4% increase in operating income in the face of flat interest expense.

Working capital is a use of $23 million, an improvement from the use of $30 million as of the end of the first quarter.

The $34 million swing from an $11 million source in the first half of 2005 to the $23 million use this year is due primarily to higher incentive compensation earned for 2005 performance but paid in Q1 2006.

Other bonus payments and lower payroll accruals in 2006 compare to the same period in 2005.

Finally, the $154 million of capital expenditures shown here is $15 million higher than the $139 million presented on the previous slide.

This is due to the large year-end accrual that reversed into 2006; or said differently, we paid $15 million for -- in cash in 2006 for assets we acquired in the back half of 2005.

Now let's look at our debt statistics as shown on slide 14.

All of these statistics are presented pro forma for our recent sale of $200 million of 8.75% senior subordinate notes and the application of the net proceeds we received.

The successful completion of the offering and the subsequent use of proceeds gives us improved liquidity, extends our weighted average maturity and increases our percentage of fixed-rate debt.

As you may have seen, Moody's issued a press release earlier this week assigning a b3 rating for the new bonds.

Also announced in that release were upgrades of our remaining senior subordinated debt from triple-C level to B3 and our U.S.-based senior secured credit facilities from -- to BA3 from B2.

The outlook for the rating is stable according to the press release.

Please turn now to slide 15.

Before I get to our guidance for the third quarter and the balance of the year, I want to remind you of some items that will impact our results for the third quarter.

The first two have no impact on OIBDA but they do impact net income.

First, we expect to take approximately $3 million of primarily non-cash charges related to the bond offering and the associated retirement of existing debt.

Second, our tax rate will return to historical levels and should be about 42% for the balance of the year.

As Richard discussed in his remarks, we experienced two fires in July; one in Ottawa, Canada and a major fire in London, England.

We believe we have sufficient insurance to cover these events.

Each incident carries a $750,000 deductible before our insurance kicks in.

We expect to incur fire-related expenses in the third quarter to exhaust each deductible.

Finally, let's look at our guidance on slide 16.

Today, we expect our third quarter revenues to be in the range of $582 million to $596 million.

And OIBDA to be between $150 million and $157 million.

Depreciation and amortization should be approximately $53 million.

We have high confidence in our revenue range for Q3, but our OIBDA range is a little less certain due to the uncertainty around the nature and timing of fire-related expenses.

At this point, we cannot precisely forecast the timing and net impact of the additional costs and related insurance recovery.

However, as concerns full-year guidance, we currently believe our 2006 OIBDA guidance is appropriate even in light of these recent extraordinary events.

We have also chosen not to update revenue guidance at this time.

We do not wish to signal any revenue weakness in the second half, however, as we currently believe full-year revenue will be around or possibly exceed the high-end of the guidance we have shown.

We will revisit our 2006 guidance at our investor day event in two months.

Thank you.

We will now open the phones to take your questions.

Thank you. [ OPERATOR INSTRUCTIONS ] Your first question comes from the line of Michael Schneider with Robert W. Baird.

Please proceed.

Good morning, guys.

Morning, Michael.

First, just a -- on the enterprise selling initiative, you've obviously ramped the resources there.

How do you get a sense or how do you get comfortable that indeed, you're getting the productivity out of this investment because we obviously see the impact in higher SG&A market, or higher SG&A expenses, but what type of growth do you expect?

How do you know you're getting productivity and how and the growth compare to the 22% you posted last year in that silo?

Well, the way we measured it, you know, sort of a book-to-business concept.

In other words, you look at the accounts in the categories, how they grow before and after, and we're comfortable that, you know, those growth rates are solid and they're higher than our average growth rates for account base.

So, you know, that's the basic way we look at it.

You can also back off and look at the Delta revenue you get over what your average growth rate was or the Delta revenue you're getting as you increase it for the book-to-business and look at the expenses you're spending to see if the paybacks there and the answer is, yeah, it's working.

There is a -- Mike, I would add that most of the mix shift in selling resources went into a middle tier of sales executives who are calling on 1,200 very large accounts.

That group expanded just in January and over the course of the first half of the year and it's too early to measure with precision what they're doing.

It's not only the global accounts that we're interested in tracking from a standpoint of increased investments, but it's a whole another class of accounts.

That's kind of early.

So, presumably because you have expanded the client set that is being targeted, the 22% growth last year should be a minimum for what you expect this year?

Well, I'm not sure if I would say it's a much bigger set of accounts.

A lot of which has just gotten started.

The way you think about it is we have placed our accounts in three big buckets, rather than two and as John said, we invested significantly in the middle tier.

I don't know that we would expect that tier to grow quite that fast.

Okay.

But it's new.

It's -- and the ratio of coverage.

The number of people per account is different.

Your cost for accounts is different.

You wouldn't expect that low.

Okay.

Just the North American box business, can you split that 9% down between price and volume, John?

First of all, it's a rounded number, so, no change there.

Volumes been stable and 6% to 7% range of price has been 1% to 2%.

Okay, and then final question, on the issue of pricing, we talked in our conferences this quarter just about your willingness now to actually walk away from the largest accounts under objection to price.

Can you give us any examples or indeed how that strategy is working?

No.

We couldn't wouldn't want to publicly talk about those events.

No one's won the award yet?

No.

Thank you.

The next question comes from Michel Morin with Merrill Lynch.

Yes.

Good morning, guys.

I wanted to focus on gross margin performance.

They were flat year-on-year.

But I think this is a record or certainly going back a few years.

It's as high as it's ever been.

You mentioned a couple of things.

I was wondering if you could expand a bit on that.

Is there anything that can't be totally recurring in that?

Thank you.

No, there is nothing, non-recurring, just good execution.

Particularly in North America and we do get a little benefit from the mix shift because digital has higher gross margins than the rest of the business and, again, those things, Iron Mountain Europe's margins were stable and then the big action was the acquisitions diluting that a bit.

We do have some headwinds in that space; both energy costs and utilities, we'll continue to push on us a little bit.

And I think, you know, sort of depends on what inflation does and what the outlook for wages are.

It's a labor-sensitive business.

And so forth, but we also, at the same time, focusing on the continuing to drive the productivity.

So the goal is to overcome one with the another -- other and so forth.

Okay, thank you.

Just a second quick one.

The CapEx has ramped up this year if we look at it as a percentage of sales.

I know it's a bit early but looking out to 2007, do you have any early plans in terms of, you know, how should we think about that?

Should it remain at elevated levels or is there some hope we might see some start to decline a bit?

One of the things we are going to exercise extreme discipline is we're not going to talk about the future until we have the future planned.

We haven't built our plans for the next year and so it's just too early for me to tell.

That's fine.

Thank you.

Your next question comes from the line of Pete Carrillo with Citigroup.

Please proceed.

Hi, guys, the first question is on the revenue guidance here.

If you come in and do the high-end this next quarter, in order to not exceed the high-end for the full-year, you guys would have to have the worst revenue quarter you ever had, at least from your numbers I can figure in the past.

You need growth of like 8.6%, I think.

In the fourth quarter.

Can you talk about what kind of things you can see going wrong in the fourth quarter that would make you have revenues only of $2.32 billion?

No, we expect, first of all, you know, the business is very stable and as inexorable momentum around storage, so Q3 and Q4 storage revenue will set new records and will have me reporting 72 consecutive quarters at the end of the year.

Services are seasonally effected by the summer doldrums and then the holiday seasons and different business lines have different characteristics there.

If you take our first day of revenue, just simply multiply it by two and understand we made some medial acquisitions, you know, it -- you could easily get yourself to believing that the high-end is very achievable and we might exceed it and that's, it's our expectation.

We'll update and boost that guidance up at our investor day.

Okay, so, I guess again, the point of caution at this point -- I understand the issue of the fires, whatever.

But the point of caution of revenues then for the fourth quarter is --

We we just deferred updating -- .

Be careful.

We're not speaking on caution of revenue.

Right.

We just didn't raise guidance.

Okay, great.

Thanks.

We didn't want to do things in piecemeal fashion when we can put the whole picture together for you in two months.

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

Please proceed.

Thanks.

Good morning, guys.

A couple big picture questions starting -- I was focusing on acquisitions for a minute.

I guess we've seen some press announcements that Rambles is considering selling Recall which would basically complete the break up the company if they chose to do that.

I am curious if from an antitrust perspective, you think the Iron Mountain could even consider acquiring Recall and if you think that would be doable, whether you would in fact be interested?

I wouldn't want to speculate on that one bit.

Okay.

Fair enough.

The next question related to that, you know, in the Q1 conference call, you talked about some of the integration problems you were having with the recent acquisitions.

I think LiveVault was one of the bigger issues.

You also got Pickfords, DigiGuard, secure destruction, the Indian joint venture and a few other presumably more recent deals that were closed in Q2.

Can you give us an update generally on, number one, the acquisition pipeline and number two, how the recent deals have performed?

First of all, I would say we're not, we're not disappointed with integration or -- in any meaningful respect.

We were just disappointed with our ability to see clearly the confluence and the impact on margins but that's behind us now.

We - the only problem we cited was that LiveVault's newest release was a little early and we were going to have to revisit that license software product, but for bringing that back to market very ably.

So, when you look at the new stuff we have done, DigiGuard and Modi in India are very, very small.

Much of our expenditures for CapEx in the quarter were to buy out partners, take total control of certain geographies.

I would say our acquisition pipeline is sort of -- is average right now and -- but things can pop up quickly or drop off quickly.

Just to push a little more that, John, what would be a reasonable expectation for capital spending for acquisitions over the next one to two years.

On the one hand, your U.S. businesses are increasingly mature but you have been expanding geographically and you have the other lines of service, digital shredding, et cetera, that you're expanding into.

I'm just kind of curious what the implications are for the total level of debt in terms of what that incremental acquisition spending would be on top of your capital budget?

We have never forecasted acquisitions spend; it's just an opportunity to be wrong.

And so, we'll, we'll adhere to our well-articulated strategy but we're not going to -- we, we would be misleading to say we have good visibility nor artificial, you know, targets around and an opportunity set that we can see clearly.

What we have said and we can repeat is the bread and butter acquisitions.

They still there and we're still in the market.

You know, historically, that is $50 million give and take in a year.

And that anything else would be -- would be either strategically driven and, you know, they're just not -- you know the math.

You know the candidates.

There is just not a lot of large candidates in the world of physical business and the digital space, yeah, we constantly keep looking out in that space just to fill up product, fill our strategic platforms.

There might be things there.

They're not, I would say that if you look out over the next three to four or five years, our acquisition spend probably on a cumulative basis wouldn't be greater than our cash flow, you know, free cash flow.

That may not be true.

But life will find out.

You never know what comes around the corner.

I think you can expect that the business to continue to delever.

In one quarter one way and one quarter the next, maybe, but over the time period, the business will continue to delever.

And to your point of debt balances.

It will delever.

Okay.

And two, real quick, one for John as well.

Could you quantify the year of your impact on the energy cost increase on the gross margin as well as what the bad debt expense was in the quarter?

Energy's 50 bips year-to-date, obviously the wrong way.

So we're particularly pleased with our gross margin performance in light of that and debt for the quarter was 30 bips against 20 last year.

We're really -- actually bad debt's kind of settling down to being what we think is sort of ambient level bad debt.

Okay, thank you.

Your next question comes from the line of Sam Taylor with Portland House Group.

Please proceed.

Hi, you said before that maintenance CapEx is about 20% of total CapEx.

If you cut CapEx to that level of business, it would cease to grow on a volumetric basis.

Presumably, your customers will generally want the store more year-over-year.

So in practice, you couldn't really cut CapEx to level.

My question is how low could it go and will CapEx always exceed depreciation?

I never use absolutes, so always is tough to answer.

CapEx is about 15%, if I get -- maintenance CapEx about 15 % of total Cap Ex right now, runs 2% of revenue.

Obviously, that may change modestly going forward based on the nature of the new -- the new businesses we're in.

We don't know and that would -- we don't know any way to manage demand from our customers, so we think we were blessed with a business that allows us to continuously redeploy capital and growth.

Obviously, we can make the number what we want by exercising, you know, by exer -- by changing our investment and selling but I -- I guess in my economic lifetime, I think that total Cap Ex will always exceed depreciation.

Okay.

Great.

Thanks.

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

Please proceed.

Hi there, John, could you just review.

Last quarter there was a comment that you thought you had reduced visibility, I think it was particularly tied to the North American reorganization.

Could you describe where you think you are in terms of, you know, sort of vigorous budgeting, normal visibility and just overall how that ties into the North American reorganization.

We have a confluence around year end , again, five strategic acquisitions and then a reorganization that required us to change where we budgeted over 2,000 overhead people in North America and it was very difficult to do year-over-year comparisons as a result and our budget process was long extended and so we, we had to revise guidance.

We're very certain of a couple of things.

One, we're forecasting the business with increasing rigor and accuracy monthly, on a monthly basis now.

We're not going to reorg again.

We have a more stable environment and we feel like we're on top of and in control of overhead spending.

Thanks.

And how about when you think you could see some of the benefits of the North American reorganization?

I think you see them already.

North American physical has higher gross margins than last year even in the face of energy headwinds and the curve will play out over time, but that business unit expects to increase its gross margins each year the next few years.

Thank you very much.

Your next question comes from the line of Riley McCormack with Tracer.

Please proceed.

Hi, thanks for taking my questions.

I was looking at your cash flows and if I take the free cash flow you've given and subtract the number you've given for acquisitions at that increased debt, I should -- the cash should have increased by about $20 million but it's approximately flat.

Was there maybe $20 million put into a JV which is not included in the line you've called cash pay acquisitions and investments?

No, it all relates to a technical issue around foreign exchange changes where debt is mark-to-market based on the U.S. dollar exchange rate.

Yeah, I asked the same question.

It's in the technical issues.

Okay, thank you very much.

Your next question comes from the line of Douglas Pratt with Mesa Capital.

Please proceed.

Thank you very much, following up on your earlier question regarding bad debt expense, you said 30 basis points versus 20.

I assume you're saying that versus revenue.

Can you tell us what the actual bad debt number was, please?

Yes.

For the quarter it was $1.6 million.

How does that compare to last year in the first quarter?

Last year, same quarter last year was 20 basis points or $1 million on $0.5 billion revenue.

Okay, so it's increasing.

Why is it that the reserve for bad debt is declining then?

I would think theoretically as a percent of total receivables, I would think you would either keep that constant or grow it in line with receivable growth.

It looks like it's going down even though bad debt is increasing.

Proportional to AT it has been coming down the last few years as we have integrated the businesses we have bought, centralized our collection functions and basically have better performance.

We have a very specific and consistent formulaic approach to calculating that reserve and we just, -- we have brought it down because of the analytical techniques suggest it should be logged.

So even though bad debt is going up, you will continue to bring the reserve down or -- ?

Bad debt's only going up because we're taking less of the reserve down.

In, you know, in large part.

I don't follow that.

You say your reserves are going down because what?

Reserves are going down because we're collecting better, have better visibility and, you know, our analytical technique to take specific and general reserves, which has been consistently applied, suggests that it should be at the levels it's at.

Okay, does that mean we shouldn't expect to see any increase on the dollar amount of bad debt then?

The 1.6 maybe?

So, $6 million or so a year should be the normal run rate?

I would say that, you know, our bad debt expense should be inside 50 basis points, but I don't know exactly where and, obviously, therefore, it will rise with the size of the business, but the characteristics of it haven't changed over time.

Okay, and -- thanks for your answer.

So it will rise besides the business which makes sense does.

Does that mean the reserve then will also rise from this level as a percent of the business?

In other words it will not go down as I percent of the business anymore?

No.

Okay, thank you.

There are currently no further questions in queue.

Will there be closing remarks?

Yes, thank you very much.

And we are going to live with our commitment to have this done in an hour and I think we'll be done.

Thank you for coming today.

As I said in the beginning, our businesses and organizations are performing well.

I really want to thank our organizations both in Canada and London and for that matter here in the U.S. for really working around the clock because of these incidents we have had.

These are never good.

We will survive and it really causes us to -- it's something we take seriously and frankly something I take very personally.

It hasn't been a good time on a personal basis for me and for a lot of other people that have been in the middle of the trenches in this thing.

And certainly not for our customers who have suffered losses in this.

But, absent that as we try to say, our businesses have done well and they're performing, the markets are coming to us.

We are -- our investments are paying off and we're running the business on track.

We are making another change.

Our investor days, as Stephen said in the beginning, is October 5 which is a little earlier than prior years.

It will be in New York City.

Invitations and notices if not out will go out soon and so forth.

The other thing we're going to change to give you a heads up, historically at our investor day this time of the year, we not only get up and talk about the execution of the business, the strategy of the business but we also forecast guidance for the coming year.

We are going to separate that and we are not going to hang ourselves as we did last year.

We're going to talk about the strategy business.

You're going to get to be introduced to some of the new team that we talked about, as long as as well as the old team and give you a chance to really understand what is on our mind and what we're thinking about doing.

But that early in the year and for that matter intentionally, we want to focus on the strategy business and a little longer review.

We will, therefore, separate our guidance.

We will give guidance for '07 but we'll do it sometime after the first of the year, probably in the January-February timeframe and it may even be tied to our end-of-the-year conference call.

Or we may have a separate one.

We haven't decide ahead yet.

As we decide, we'll let you know that.

We look forward to seeing many of you in a couple of months and we appreciate you coming and I hope you have a good summer.

Thank you.

Thank you for your attendance in today's conference; this concludes the presentation.

You may now disconnect.

Good day.