Use these links to rapidly review the document TABLE OF CONTENTS
Table of Contents
UNITED STATESSECURITIES AND EXCHANGE COMMISSION Washington, DC 20549
FORM 10-Q
Commission file number 1-13045
IRON MOUNTAIN INCORPORATED (Exact Name of Registrant as Specified in Its Charter)
745 Atlantic Avenue, Boston, MA 02111(Address of Principal Executive Offices, Including Zip Code)
(617) 535-4766(Registrant's Telephone Number, Including Area Code)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ý No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a small reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No ý
Number of shares of the registrant's Common Stock at October 24, 2011: 185,617,679
IRON MOUNTAIN INCORPORATED
Index
PART I—FINANCIAL INFORMATION
Item 1—Unaudited Consolidated Financial Statements
Consolidated Balance Sheets at December 31, 2010 and September 30, 2011 (Unaudited)
Consolidated Statements of Operations for the Three Months Ended September 30, 2010 and 2011 (Unaudited)
Consolidated Statements of Operations for the Nine Months Ended September 30, 2010 and 2011 (Unaudited)
Consolidated Statements of Equity for the Nine Months Ended September 30, 2010 and 2011 (Unaudited)
Consolidated Statements of Comprehensive Income (Loss) for the Three and Nine Months Ended September 30, 2010 and 2011 (Unaudited)
Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2010 and 2011 (Unaudited)
Notes to Consolidated Financial Statements (Unaudited)
Item 2—Management's Discussion and Analysis of Financial Condition and Results of Operations
Item 4—Controls and Procedures
PART II—OTHER INFORMATION
Item 1—Legal Proceedings
Item 2—Unregistered Sales of Equity Securities and Use of Proceeds
Item 6—Exhibits
Signatures
2
INCORPORATED CONSOLIDATED BALANCE SHEETS (In Thousands, except Share and Per Share Data) (Unaudited)
ASSETS
Current Assets:
Cash and cash equivalents
Restricted cash
Accounts receivable (less allowances of $21,545 and $23,012, as of December 31, 2010 and September 30, 2011, respectively)
Deferred income taxes
Prepaid expenses and other
Assets of discontinued operations (see Note 10)
Total Current Assets
Property, Plant and Equipment:
Property, plant and equipment
Less—Accumulated depreciation
Property, Plant and Equipment, net
Other Assets, net:
Goodwill
Customer relationships and acquisition costs
Deferred financing costs
Other
Total Other Assets, net
Total Assets
LIABILITIES AND EQUITY
Current Liabilities:
Current portion of long-term debt
Accounts payable
Accrued expenses
Deferred revenue
Liabilities of discontinued operations (see Note 10)
Total Current Liabilities
Long-term Debt, net of current portion
Other Long-term Liabilities
Deferred Rent
Deferred Income Taxes
Commitments and Contingencies (see Note 8)
Equity:
Iron Mountain Incorporated Stockholders' Equity:
Preferred stock (par value $0.01; authorized 10,000,000 shares; none issued and outstanding)
Common stock (par value $0.01; authorized 400,000,000 shares; issued and outstanding 200,064,066 shares and 186,615,930 shares, as of December 31, 2010 and September 30, 2011, respectively)
Additional paid-in capital
Retained earnings
Accumulated other comprehensive items, net
Total Iron Mountain Incorporated Stockholders' Equity
Noncontrolling Interests
Total Equity
Total Liabilities and Equity
The accompanying notes are an integral part of these consolidated financial statements.
3
IRON MOUNTAIN INCORPORATED CONSOLIDATED STATEMENTS OF OPERATIONS (In Thousands, except Per Share Data) (Unaudited)
Revenues:
Storage (see Note 2.q.)
Service (see Note 2.q.)
Total Revenues
Operating Expenses:
Cost of sales (excluding depreciation and amortization)
Selling, general and administrative
Depreciation and amortization
Intangible impairments
(Gain) Loss on disposal/write-down of property, plant and equipment, net
Total Operating Expenses
Operating Income (Loss)
Interest Expense, Net (includes Interest Income of $162 and $614 for the three months ended September 30, 2010 and 2011, respectively)
Other Expense (Income), Net
Income (Loss) from Continuing Operations Before Provision (Benefit) for Income Taxes
Provision (Benefit) for Income Taxes
Income (Loss) from Continuing Operations
Income (Loss) from Discontinued Operations (see Note 10), Net of Tax
Gain (Loss) on Sale of Discontinued Operations (see Note 10), Net of Tax
Net Income (Loss)
Less: Net Income (Loss) Attributable to Noncontrolling Interests
Net Income (Loss) Attributable to Iron Mountain Incorporated
Earnings (Losses) per Share—Basic:
Total Income (Loss) from Discontinued Operations
Earnings (Losses) per Share—Diluted:
Weighted Average Common Shares Outstanding—Basic
Weighted Average Common Shares Outstanding—Diluted
Dividends Declared per Common Share
4
IRON MOUNTAIN INCORPORATED CONSOLIDATED STATEMENTS OF OPERATIONS (Continued) (In Thousands, except Per Share Data) (Unaudited)
Interest Expense, Net (includes Interest Income of $952 and $1,658 for the nine months ended September 30, 2010 and 2011, respectively)
5
IRON MOUNTAIN INCORPORATED CONSOLIDATED STATEMENTS OF EQUITY (In Thousands, except Share Data) (Unaudited)
Balance, December 31, 2009
Issuance of shares under employee stock purchase plan and option plans and stock-based compensation, including tax benefit of $1,913
Stock options issued in connection with an acquisition
Stock repurchases
Parent cash dividends (see Note 9)
Comprehensive Income (Loss):
Currency translation adjustment
Net income (loss)
Comprehensive Income (Loss)
Noncontrolling interests dividends
Balance, September 30, 2010
Balance, December 31, 2010
Issuance of shares under employee stock purchase plan and option plans and stock-based compensation, including tax benefit of $578
Noncontrolling interests equity contributions
Balance, September 30, 2011
6
IRON MOUNTAIN INCORPORATED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (In Thousands) (Unaudited)
Net (Loss) Income
Other Comprehensive Income (Loss):
Foreign Currency Translation Adjustments
Total Other Comprehensive Income (Loss)
Comprehensive (Loss) Income
Comprehensive Income (Loss) Attributable to Noncontrolling Interests
Comprehensive (Loss) Income Attributable to Iron Mountain Incorporated
Total Other Comprehensive (Loss) Income
7
IRON MOUNTAIN INCORPORATED CONSOLIDATED STATEMENTS OF CASH FLOWS (In Thousands) (Unaudited)
Cash Flows from Operating Activities:
(Income) Loss from discontinued operations (see Note 10)
(Gain) Loss on sale of discontinued operations (see Note 10)
Adjustments to reconcile net income (loss) to cash flows from operating activities:
Depreciation
Amortization (includes deferred financing costs and bond discount of $3,985 and $4,520 for the nine months ended September 30, 2010 and 2011, respectively)
Stock-based compensation expense
Provision for deferred income taxes
Loss on early extinguishment of debt, net
(Gain) Loss on disposal/writedown of property, plant and equipment, net
Foreign currency transactions and other, net
Changes in Assets and Liabilities (exclusive of acquisitions):
Accounts receivable
Prepaid expenses and other current assets
Accrued expenses, deferred revenue and other current liabilities
Other assets and long-term liabilities
Cash Flows from Operating Activities—Continuing Operations
Cash Flows from Operating Activities—Discontinued Operations
Cash Flows from Operating Activities
Cash Flows from Investing Activities:
Capital expenditures
Cash paid for acquisitions, net of cash acquired
Investment in restricted cash
Additions to customer relationship and acquisition costs
Proceeds from sales of property and equipment and other, net
Cash Flows from Investing Activities—Continuing Operations
Cash Flows from Investing Activities—Discontinued Operations
Cash Flows from Investing Activities
Cash Flows from Financing Activities:
Repayment of revolving credit and term loan facilities and other debt
Proceeds from revolving credit and term loan facilities and other debt
Early retirement of senior subordinated notes
Net proceeds from sales of senior subordinated notes
Debt financing (repayment to) and equity contribution from (distribution to) noncontrolling interests, net
Parent cash dividends
Proceeds from exercise of stock options and employee stock purchase plan
Excess tax benefits from stock-based compensation
Payment of debt financing costs
Cash Flows from Financing Activities—Continuing Operations
Cash Flows from Financing Activities—Discontinued Operations
Cash Flows from Financing Activities
Effect of Exchange Rates on Cash and Cash Equivalents
(Decrease) Increase in Cash and Cash Equivalents
Cash and Cash Equivalents, Beginning of Period
Cash and Cash Equivalents, End of Period
Supplemental Information:
Cash Paid for Interest
Cash Paid for Income Taxes
Non-Cash Investing and Financing Activities:
Capital Leases
Accrued Capital Expenditures
Dividends Payable
Unsettled Purchases of Parent Common Stock
8
IRON MOUNTAIN INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In Thousands, Except Share and Per Share Data) (Unaudited)
(1) General
The interim consolidated financial statements are presented herein without audit and, in the opinion of management, reflect all adjustments of a normal recurring nature necessary for a fair presentation. Interim results are not necessarily indicative of results for a full year. We are a global, full-service provider of information management and related services for all media in various locations throughout North America, Europe, Latin America and Asia Pacific. We have a diversified customer base comprised of commercial, legal, banking, health care, accounting, insurance, entertainment and government organizations.
The unaudited consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC"). Certain information and footnote disclosures normally included in the annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP") have been omitted pursuant to those rules and regulations, but we believe that the disclosures included herein are adequate to make the information presented not misleading. The consolidated financial statements and notes included herein should be read in conjunction with the annual consolidated financial statements and notes for the year ended December 31, 2010 included in our Current Report on Form 8-K filed on September 19, 2011.
In August 2010, Iron Mountain Incorporated ("IMI") divested the domain name management product line of our digital business (the "Domain Name Product Line"). On June 2, 2011, IMI completed the sale (the "Digital Sale") of our online backup and recovery, digital archiving and eDiscovery solutions businesses of our digital business (the "Digital Business") to Autonomy Corporation plc, a corporation formed under the laws of England and Wales ("Autonomy"), pursuant to a purchase and sale agreement dated as of May 15, 2011 among IMI, certain subsidiaries of IMI and Autonomy (the "Digital Sale Agreement"). The financial position, operating results and cash flows of the Domain Name Product Line and the Digital Business, for all periods presented, including the gains on the sales, have been reported as discontinued operations for financial reporting purposes. Additionally, in May 2011, IMI committed to a plan to sell our records management business in New Zealand (the "New Zealand Business"). The New Zealand Business was sold on October 3, 2011. The financial position, operating results and cash flows of the New Zealand Business, for all periods presented, have been reported as discontinued operations for financial reporting purposes. See "Note 10. Discontinued Operations" for a further discussion of these events.
(2) Summary of Significant Accounting Policies
a. Principles of Consolidation
The accompanying financial statements reflect our financial position, results of operations and cash flows on a consolidated basis. All intercompany account balances have been eliminated.
b. Cash and Cash Equivalents and Restricted Cash
Cash and cash equivalents include cash on hand and cash invested in short-term securities, which have remaining maturities at the date of purchase of less than 90 days. Cash and cash equivalents are carried at cost, which approximates fair value.
9
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In Thousands, Except Share and Per Share Data)
(Unaudited)
(2) Summary of Significant Accounting Policies (Continued)
We have restricted cash associated with a collateral trust agreement with our insurance carrier that was entered into in 2010 related to our worker's compensation self-insurance program. The restricted cash subject to this agreement was $35,105 and $35,109 as of December 31, 2010 and September 30, 2011, respectively, and is included in current assets on our consolidated balance sheets. Restricted cash consists primarily of U.S. Treasuries.
c. Foreign Currency
Local currencies are considered the functional currencies for our operations outside the United States, with the exception of certain foreign holding companies and our financing center in Switzerland, whose functional currencies are the U.S. dollar. In those instances where the local currency is the functional currency, assets and liabilities are translated at period-end exchange rates, and revenues and expenses are translated at average exchange rates for the applicable period. Resulting translation adjustments are reflected in the accumulated other comprehensive items, net component of Iron Mountain Incorporated Stockholders' Equity and Noncontrolling Interests. The gain or loss on foreign currency transactions, calculated as the difference between the historical exchange rate and the exchange rate at the applicable measurement date, including those related to (a) our 71/4% GBP Senior Subordinated Notes due 2014, (b) our 63/4 Euro Senior Subordinated Notes due 2018, (c) the borrowings in certain foreign currencies under our revolving credit agreement, and (d) certain foreign currency denominated intercompany obligations of our foreign subsidiaries to us and between our foreign subsidiaries, which are not considered permanently invested, are included in other expense (income), net, on our consolidated statements of operations. The total gain or loss on foreign currency transactions amounted to a net gain of $3,972 and net loss of $4,979 for the three and nine months ended September 30, 2010, respectively. The total gain or loss on foreign currency transactions amounted to a net loss of $15,624 and $14,381 for the three and nine months ended September 30, 2011, respectively.
d. Goodwill and Other Intangible Assets
Goodwill and intangible assets with indefinite lives are not amortized but are reviewed annually for impairment or more frequently if impairment indicators arise. Other than goodwill, we currently have no intangible assets that have indefinite lives and which are not amortized. Separable intangible assets that are not deemed to have indefinite lives are amortized over their useful lives. We periodically assess whether events or circumstances warrant a change in the life over which our intangible assets are amortized.
We have selected October 1 as our annual goodwill impairment review date. We performed our most recent annual goodwill impairment review as of October 1, 2010 and noted no impairment of goodwill. As of December 31, 2010 and September 30, 2011, no factors were identified, other than those factors related to our European operations discussed below, that would alter our October 1, 2010 goodwill assessment. In making this assessment, we relied on a number of factors including operating results, business plans, anticipated future cash flows, transactions and marketplace data. There are inherent uncertainties related to these factors and our judgment in applying them to the analysis of goodwill impairment. When changes occur in the composition of one or more reporting units, the goodwill is reassigned to the reporting units affected based on their relative fair values. As discussed at
10
Note 10, we recorded a goodwill impairment charge in 2010 associated with our former worldwide digital business reporting unit. For the year ended December 31, 2010, we allocated $85,909 of this charge ($76,500 in the third quarter of 2010 and $9,409 in the fourth quarter of 2010) to the technology escrow services business based on a relative fair value basis. This charge continues to be included in our continuing results of operations as a component of intangible impairments in our consolidated statements of operations as we retained this business following the Digital Sale. Our technology escrow services business, which had been reported in our former worldwide digital business reporting segment, is now reported as a component of our North American Physical Business segment.
In September 2011, as a result of certain changes we made in the manner in which our European operations will be managed, we reorganized our reporting structure and reassigned goodwill among the revised reporting units. Previously, we tested goodwill impairment at the European level on a combined basis. As a result of the management and reporting changes, we concluded that we have three reporting units for our European operations: (1) the United Kingdom, Ireland and Norway ("UKI"), (2) Belgium, France, Germany, Italy, Luxembourg, Netherlands and Spain ("Western Europe") and (3) the remaining countries in Europe ("Central Europe"). Due to these changes, we will perform all future goodwill impairment analysis on the new reporting unit basis. As a result of the restructuring of our reporting units, we concluded that we had an interim triggering event, and, therefore, we performed an interim goodwill impairment test for UKI, Western Europe and Central Europe in the third quarter of 2011. As required by GAAP, prior to our goodwill impairment analysis we performed an impairment test on the long-lived assets within our Western Europe reporting unit. The undiscounted cash flows from our Italian operations were lower than the carrying value of the long-lived assets associated with these operations and resulted in the requirement to fair value the long-lived assets of this lower level component. As a result, we recorded write-offs of other intangible assets, primarily customer relationship values, of $8,000 during the quarter ending September 30, 2011, associated with our Italian operations which are a component of our Western Europe reporting unit. We also recorded certain write-downs to property, plant and equipment (primarily racking) long-lived assets in Italy as more fully discussed at Note 2.p. Additionally, we concluded that the goodwill of our UKI and Central Europe reporting units were not impaired. Our UKI and Central Europe reporting units have fair values that exceed their carrying values by 15.1% and 5.0%, respectively, as of August 31, 2011. Central Europe is still in the investment stage and accordingly its fair value does not exceed its carrying value by a significant margin at this point in time. A deterioration of the UKI or Central Europe businesses or the businesses not achieving the forecasted results could lead to impairments in future periods. Our Western Europe reporting unit's fair value was less than its carrying value, and, as a result, we recorded a provisional goodwill impairment charge included as a component of intangible impairments in our consolidated statements of operations for the quarter ending September 30, 2011 of $45,000. An estimated tax benefit of approximately $6,500 was recorded associated with the Western Europe provisional goodwill impairment charge. The provisional charge is subject to refinement of forecast assumptions and results and valuation analyses necessary to calculate an implied fair value for goodwill. After the provisional impairment, the remaining Western Europe reporting unit goodwill is $52,588. We will finalize the provisional charge and record any necessary adjustments in the fourth quarter of 2011 (including to the estimated tax benefit).
11
Our reporting units at which level we performed our goodwill impairment analysis as of October 1, 2010 were as follows: North America; Europe; Latin America; Australia and Joint Ventures (which includes India, the various joint ventures in Southeast Asia and Russia (referred to as "Joint Ventures")). As of December 31, 2010, the carrying value of goodwill, net amounted to $1,750,420, $440,920, $29,787 and $61,010 for North America, Europe, Latin America and Australia, respectively. Our Joint Ventures reporting unit had no goodwill as of December 31, 2010. Our reporting units at which level we will perform our goodwill impairment analysis as of October 1, 2011 are as follows: North America; UKI; Western Europe; Central Europe; Latin America; Australia; and Joint Ventures. As of September 30, 2011, the carrying value of goodwill, net amounted to $1,742,856, $312,741, $52,588, $63,714, $27,347, and $59,841 for North America, UKI, Western Europe, Central Europe, Latin America and Australia, respectively. Our Joint Ventures reporting unit has no goodwill as of September 30, 2011.
Reporting unit valuations have been calculated using an income approach based on the present value of future cash flows of each reporting unit or a combined approach based on the present value of future cash flows and market and transaction multiples of revenues and earnings. The income approach incorporates many assumptions including future growth rates, discount factors, expected capital expenditures and income tax cash flows. Changes in economic and operating conditions impacting these assumptions could result in goodwill impairments in future periods.
The changes in the carrying value of goodwill attributable to each reportable operating segment for the nine months ended September 30, 2011 is as follows:
Balance as of December 31, 2010
Deductible goodwill acquired during the year
Non-deductible goodwill acquired during the year
Goodwill impairment
Fair value and other adjustments(1)
Currency effects
Balance as of September 30, 2011(2)
12
The components of our amortizable intangible assets at September 30, 2011 are as follows:
Customer Relationships and Acquisition Costs
Core Technology(1)
Trademarks and Non-Compete Agreements(1)
Deferred Financing Costs
Total
Amortization expense associated with amortizable intangible assets (including deferred financing costs) was $7,595 and $22,819 for the three and nine months ended September 30, 2010, respectively, and was $8,640 and $25,147 for the three and nine months ended September 30, 2011, respectively.
e. Stock-Based Compensation
We record stock-based compensation expense, utilizing the straight-line method, for the cost of stock options, restricted stock, restricted stock units, performance units and shares of stock issued under the employee stock purchase plan (together, "Employee Stock-Based Awards").
Stock-based compensation expense for Employee Stock-Based Awards included in the accompanying consolidated statements of operations for the three and nine months ended September 30, 2010 was $4,750, including $737 in discontinued operations, ($3,819 after tax or $0.02 per basic and diluted share), and $15,559, including $2,429 in discontinued operations, ($12,240 after tax or $0.06 per basic and diluted share), respectively. Stock-based compensation expense for Employee Stock-Based Awards for the three and nine months ended September 30, 2011 was $4,403 ($2,479 after tax or $0.01 per basic and diluted share), and $12,702, including $260 in discontinued operations, ($5,213 after tax or $0.03 per basic and diluted share), respectively.
Stock-based compensation expense for Employee Stock Based Awards included in the accompanying consolidated statements of operations related to continuing operations is as follows:
Selling, general and administrative expenses
Total stock-based compensation
13
The benefits associated with the tax deductions in excess of recognized compensation cost are required to be reported as a financing cash flow. This requirement reduces reported operating cash flows and increases reported financing cash flows. As a result, net financing cash flows from continuing operations included $1,913 and $578 for the nine months ended September 30, 2010 and 2011, respectively, from the benefits of tax deductions in excess of recognized compensation cost. We used the short form method to calculate the Additional Paid-in Capital ("APIC") pool. The tax benefit of any resulting excess tax deduction increases the APIC pool. Any resulting tax deficiency is deducted from the APIC pool.
Stock Options
Under our various stock option plans, options were granted with exercise prices equal to the market price of the stock on the date of grant. The majority of our options become exercisable ratably over a period of five years and generally have a contractual life of ten years, unless the holder's employment is terminated. Certain of the options we issue become exercisable ratably over a period of ten years and have a contractual life of 12 years, unless the holder's employment is terminated. As of September 30, 2011, ten-year vesting options represent 7.1% of total outstanding options. Beginning in 2011, certain of the options we issue become exercisable ratably over a period of three years and have a contractual life of ten years, unless the holder's employment is terminated. As of September 30, 2011, three-year vesting options represent 10.1% of total outstanding options. Our directors are considered employees for purposes of our stock option plans and stock option reporting. Options granted to our non-employee directors generally become exercisable after one year.
The weighted average fair value of options granted for the nine months ended September 30, 2010 and 2011 was $7.93 and $7.43 per share, respectively. These values were estimated on the date of grant using the Black-Scholes option pricing model. The following table summarizes the weighted average assumptions used for grants in the respective period:
Expected volatility
Risk-free interest rate
Expected dividend yield
Expected life of option
Expected volatility is calculated utilizing daily historical volatility over a period that equates to the expected life of the option. The risk-free interest rate was based on the U.S. Treasury interest rates whose term is consistent with the expected life of the stock options. Beginning in the first quarter of 2010, expected dividend yield was considered in the option pricing model as a result of our new dividend program. The expected life (estimated period of time outstanding) of the stock options granted is estimated using the historical exercise behavior of employees.
14
A summary of option activity for the nine months ended September 30, 2011 is as follows:
Outstanding at December 31, 2010
Granted
Exercised
Forfeited
Expired
Outstanding at September 30, 2011
Options exercisable at September 30, 2011
Options expected to vest
The following table provides the aggregate intrinsic value of stock options exercised for the three and nine months ended September 30, 2010 and 2011:
Aggregate intrinsic value of stock options exercised
Restricted Stock and Restricted Stock Units
Under our various stock option plans, we may also issue grants of restricted stock or restricted stock units ("RSUs"). Our restricted stock and RSUs generally have a three to five year vesting period. The fair value of restricted stock and RSUs is the excess of the market price of our common stock at the date of grant over the purchase price (which is typically zero).
A summary of restricted stock and RSUs activity for the nine months ended September 30, 2011 is as follows:
Non-vested at December 31, 2010
Vested
Non-vested at September 30, 2011
15
The total fair value of restricted stock vested for the three and nine months ended September 30, 2010 was $0 and $13, respectively. The total fair value of restricted stock vested for the three and nine months ended September 30, 2011 was $0 and $13, respectively. No RSUs vested during the three and nine months ended September 30, 2010. The total fair value of RSUs vested for the three and nine months ended September 30, 2011 was $225 and $687, respectively.
Performance Units
Under our various stock option plans, we may also issue grants of performance units ("PUs"). The number of PUs earned will be determined based on our performance against predefined targets of calendar year revenue growth and return on invested capital ("ROIC"). The range of payout is zero to 150% of the number of granted PUs. The number of PUs earned will be determined based on actual performance at the end of the one-year performance period, and the award will be settled in shares of our common stock, subject to vesting, three years from the date of the original grant. Additionally, employees who are employed through the one-year anniversary of the date of grant and who reach both 55 years of age and 10 years of qualifying service (the "retirement criteria") shall immediately and completely vest in any PUs earned based on the actual achievement against the predefined targets as discussed above. As a result, PUs will be expensed over the shorter of (a) achievement of the retirement criteria, which such achievement may occur as early as one year after the date of grant, or (b) a maximum of three years.
In the first nine months of 2011, we issued 154,239 PUs. During the one-year performance period, we will forecast the likelihood of achieving the annual revenue growth and ROIC predefined targets in order to calculate the expected PUs to be earned. We will record a compensation charge based on either the forecasted PUs to be earned (during the one-year performance period) or the actual PUs earned (at the one-year anniversary date) over the vesting period for each individual grant as described above. The performance unit liability is remeasured at each fiscal quarter-end during the vesting period using the estimated percentage of units earned multiplied by the closing market price of our common stock on the current period-end date and is pro-rated based on the amount of time passed in the vesting period. As of September 30, 2011, we expected 102% achievement of the predefined revenue and ROIC targets associated with the grants made in the first nine months of 2011 and the closing market price of our common stock was $31.62.
A summary of PU activity for the nine months ended September 30, 2011 is as follows:
16
Employee Stock Purchase Plan
We offer an employee stock purchase plan in which participation is available to substantially all U.S. and Canadian employees who meet certain service eligibility requirements (the "ESPP"). The ESPP provides a way for our eligible employees to become stockholders on favorable terms. The ESPP provides for the purchase of our common stock by eligible employees through successive offering periods. We generally have two six-month offering periods per year, the first of which begins June 1 and ends November 30 and the second of which begins December 1 and ends May 31. During each offering period, participating employees accumulate after-tax payroll contributions, up to a maximum of 15% of their compensation, to pay the exercise price of their options. Participating employees may withdraw from an offering period before the purchase date and obtain a refund of the amounts withheld as payroll deductions. At the end of the offering period, outstanding options are exercised, and each employee's accumulated contributions are used to purchase our common stock. The price for shares purchased under the ESPP is 95% of the fair market price at the end of the offering period, without a look-back feature. As a result, we do not recognize compensation cost for the ESPP shares purchased. For the nine months ended September 30, 2010 and 2011, there were 137,200 shares and 82,267 shares, respectively, purchased under the ESPP. The number of shares available for purchase under the ESPP at September 30, 2011 was 472,053.
As of September 30, 2011, unrecognized compensation cost related to the unvested portion of our Employee Stock-Based Awards was $41,671 and is expected to be recognized over a weighted-average period of 3.0 years.
We generally issue shares for the exercises of stock options, restricted stock, RSUs, PUs and shares under our ESPP from unissued reserved shares.
f. Income (Loss) Per Share—Basic and Diluted
Basic income (loss) per common share is calculated by dividing income (loss) by the weighted average number of common shares outstanding. The calculation of diluted income (loss) per share is consistent with that of basic income (loss) per share but gives effect to all potential common shares (that is, securities such as options, warrants or convertible securities) that were outstanding during the period, unless the effect is antidilutive.
17
The following table presents the calculation of basic and diluted income (loss) per share:
Income (Loss) from continuing operations
Total Income (Loss) from discontinued operations (see Note 10)
Net income (loss) attributable to Iron Mountain Incorporated
Weighted-average shares—basic
Effect of dilutive potential stock options
Effect of dilutive potential restricted stock, RSUs and PUs
Weighted-average shares—diluted
Earnings (Losses) per share—basic:
Net income (loss) attributable to Iron Mountain Incorporated—basic
Earnings (Losses) per share—diluted:
Net income (loss) attributable to Iron Mountain Incorporated—diluted
Antidilutive stock options, RSUs and PUs, excluded from the calculation
g. Revenues
Our revenues consist of storage revenues as well as service revenues and are reflected net of sales and value added taxes. Storage revenues, which are considered a key performance indicator for the information management services industry, consist primarily of recurring periodic charges related to the storage of materials or data (generally on a per unit basis). Service revenues are comprised of charges for related core service activities and a wide array of complementary products and services. Included in core service revenues are: (1) the handling of records, including the addition of new records, temporary
18
removal of records from storage, refiling of removed records and the destruction of records; (2) courier operations, consisting primarily of the pickup and delivery of records upon customer request; (3) secure shredding of sensitive documents; and (4) other recurring services, including hybrid services and recurring project revenues. Our complementary services revenues include special project work, customer termination and permanent withdrawal fees, data restoration projects, fulfillment services, consulting services, technology services and product sales (including specially designed storage containers and related supplies). Our secure shredding revenues include the sale of recycled paper (included in complementary services revenues), the price of which can fluctuate from period to period, adding to the volatility and reducing the predictability of that revenue stream.
We recognize revenue when the following criteria are met: persuasive evidence of an arrangement exists, services have been rendered, the sales price is fixed or determinable, and collectability of the resulting receivable is reasonably assured. Storage and service revenues are recognized in the month the respective storage or service is provided and customers are generally billed on a monthly basis on contractually agreed-upon terms. Amounts related to future storage or prepaid service contracts for customers where storage fees or services are billed in advance are accounted for as deferred revenue and recognized ratably over the applicable storage or service period or when the service is performed. Revenue from the sales of products, which is included as a component of service revenues, is recognized when shipped to the customer and title has passed to the customer.
h. Allowance for Doubtful Accounts and Credit Memo Reserves
We maintain an allowance for doubtful accounts and credit memos for estimated losses resulting from the potential inability of our customers to make required payments and disputes regarding billing and service issues. When calculating the allowance, we consider our past loss experience, current and prior trends in our aged receivables and credit memo activity, current economic conditions, and specific circumstances of individual receivable balances. If the financial condition of our customers were to significantly change, resulting in a significant improvement or impairment of their ability to make payments, an adjustment of the allowance may be required. We consider accounts receivable to be delinquent after such time as reasonable means of collection have been exhausted. We charge-off uncollectible balances as circumstances warrant, generally, no later than one year past due.
i. Income Taxes
Our effective tax rates for the three and nine months ended September 30, 2010 were 51.6% and 53.6%, respectively. Our effective tax rates for the three and nine months ended September 30, 2011 were 32.7% and 26.4%, respectively. The primary reconciling item between the federal statutory rate of 35% and our overall effective tax rate for the three and nine months ended September 30, 2010 is a goodwill impairment charge included in income from continuing operations as a component of intangible impairments in our consolidated statements of operations, of which a majority was non-deductible for tax purposes. The negative impact of U.S. legislative changes reducing the expected utilization of foreign tax credits was offset by the recognition of certain previously unrecognized tax benefits due to expirations of statute of limitation periods and settlements with tax authorities in various jurisdictions. Additionally, to a lesser extent, state income taxes (net of federal benefit) and
19
differences in the rates of tax at which our foreign earnings are subject, including foreign exchange gains and losses in different jurisdictions with different tax rates, are also reconciling items and impact our effective tax rate. The primary reconciling item between the federal statutory rate of 35% and our overall effective tax rate for the three and nine months ended September 30, 2011 was a positive impact provided by the recognition of certain previously unrecognized tax benefits due to expirations of statute of limitation periods and settlements with tax authorities in various jurisdictions. During the three and nine months ended September 30, 2011, we recognized previously unrecognized tax benefits due to expirations of statute of limitation periods and settlements with tax authorities in various jurisdictions of $31,935 and $36,150, respectively. We believe that it is reasonably possible that an amount of up to approximately $5,748 of our unrecognized tax positions may be recognized by September 30, 2012 as a result of a lapse of statute of limitations or upon closing and settling certain audits in various worldwide jurisdictions. This benefit was partially offset by a goodwill impairment charge included in income from continuing operations as a component of intangible impairments in our consolidated statements of operations, of which a majority was non-deductible for tax purposes. Additionally, to a lesser extent, state income taxes (net of federal benefit) and differences in the rates of tax at which our foreign earnings are subject, including foreign exchange gains and losses in different jurisdictions with different tax rates, are reconciling items that impact our effective tax rate.
We provide for income taxes during interim periods based on our estimate of the effective tax rate for the year. Discrete items and changes in our estimate of the annual effective tax rate are recorded in the period they occur. Our effective tax rate is subject to variability in the future due to, among other items: (1) changes in the mix of income from foreign jurisdictions; (2) tax law changes; (3) volatility in foreign exchange gains and (losses); (4) the timing of the establishment and reversal of tax reserves; and (5) our ability to utilize foreign tax credits that we generate. We are subject to income taxes in the U.S. and numerous foreign jurisdictions. We are subject to examination by various tax authorities in jurisdictions in which we have significant business operations. We regularly assess the likelihood of additional assessments by tax authorities and provide for these matters as appropriate. Although we believe our tax estimates are appropriate, the final determination of tax audits and any related litigation could result in changes in our estimates.
Accounting for income taxes requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the tax and financial reporting basis of assets and liabilities and for loss and credit carryforwards. Valuation allowances are provided when recovery of deferred tax assets is not considered more likely than not.
We have elected to recognize interest and penalties associated with uncertain tax positions as a component of the provision (benefit) for income taxes in the accompanying consolidated statements of operations. We recorded a reduction of $4,214 and $1,464 for gross interest and penalties for the three and nine months ended September 30, 2010, respectively. We recorded a reduction of $6,497 and $7,753 for gross interest and penalties for the three and nine months ended September 30, 2011, respectively. We had $11,610 and $3,553 accrued for the payment of interest and penalties as of December 31, 2010 and September 30, 2011, respectively.
20
j. Concentrations of Credit Risk
Financial instruments that potentially subject us to market risk consist principally of cash and cash equivalents (including money market funds and time deposits), restricted cash (primarily U.S. Treasuries) and accounts receivable. The only significant concentrations of liquid investments as of December 31, 2010 and September 30, 2011 relate to cash and cash equivalents and restricted cash held on deposit with seven and three, respectively, global banks and four "Triple A" rated money market funds which we consider to be large, highly-rated investment-grade institutions. As per our risk management investment policy, we limit exposure to concentration of credit risk by limiting the amount invested in any one mutual fund or financial institution to a maximum of $50,000. As of December 31, 2010 and September 30, 2011, our cash and cash equivalents and restricted cash balance was $293,798 and $515,988, respectively, including money market funds and time deposits amounting to $241,151 and $459,789, respectively. A substantial portion of these money market funds are invested in U.S. Treasuries.
k. Fair Value Measurements
Entities are permitted under GAAP to elect to measure many financial instruments and certain other items at either fair value or cost. We did not elect the fair value measurement option for any of our financial assets or liabilities.
Our financial assets or liabilities are measured using inputs from the three levels of the fair value hierarchy. A financial asset or liability's classification within the hierarchy is determined based on the lowest level input that is significant to the fair value measurement.
The three levels of the fair value hierarchy are as follows:
Level 1—Inputs are unadjusted quoted prices in active markets for identical assets or liabilities that we have the ability to access atthe measurement date.
Level 2—Inputs include quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability (i.e., interest rates, yield curves, etc.), and inputs that are derived principally from or corroborated by observable market data by correlation or other means (market corroborated inputs).
Level 3—Unobservable inputs that reflect our assumptions about the assumptions that market participants would use in pricing the asset or liability.
21
The following tables provide the assets and liabilities carried at fair value measured on a recurring basis as of December 31, 2010 and September 30, 2011, respectively:
Money Market Funds(1)
Time Deposits(1)
Trading Securities
Derivative Assets(3)
Derivative Liabilities(3)
Disclosures are required in the financial statements for items measured at fair value on a non-recurring basis. We did not have any material items that are measured at fair value on a non-recurring basis for the three and nine months ended September 30, 2011, except for the matters discussed at Note 2.d. and 2.p.
l. New Accounting Pronouncements
In July 2011, the Financial Accounting Standards Board (the "FASB") issued amended guidance that revises the manner in which entities present comprehensive income in their financial statements.
22
The new guidance removes the presentation options currently available in Accounting Standards Codification ("ASC") 220 and requires entities to report components of comprehensive income in either (1) a continuous statement of comprehensive income or (2) two separate but consecutive statements. Under the two-statement approach, the first statement would include components of net income, which is consistent with the income statement format used currently under ASC 220, and the second statement would include components of other comprehensive income ("OCI"). Under either method, entities must display adjustments for items that are reclassified from OCI to net income in both net income and OCI. The amended guidance does not change the current option for entities to present components of OCI gross or net of the effect of income taxes, provided that such tax effects are presented in the statement in which OCI is presented or disclosed in the notes to the financial statements. The amended guidance does not change the items that must be reported in OCI. The amendments are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011 and must be applied retrospectively for all periods presented in the financial statements. Early adoption of the amended guidance is permitted; however, we do not intend to early adopt. Adoption is not expected to have a material impact on our consolidated financial statements or results of operations.
m. Use of Estimates
The preparation of financial statements in conformity with GAAP requires us to make estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities at the date of the financial statements and for the period then ended. On an on-going basis, we evaluate the estimates used. We base our estimates on historical experience, actuarial estimates, current conditions and various other assumptions that we believe to be reasonable under the circumstances. These estimates form the basis for making judgments about the carrying values of assets and liabilities and are not readily apparent from other sources. Actual results may differ from these estimates.
n. Accumulated Other Comprehensive Items, Net
Accumulated other comprehensive items, net consists of foreign currency translation adjustments as of December, 31, 2010 and September 30, 2011, respectively.
23
o. Other Expense (Income), Net
Other expense (income), net consists of the following:
Foreign currency transaction (gains) losses, net
Debt extinguishment expense, net
Other, net
p. Property, Plant and Equipment
We develop various software applications for internal use. Computer software costs associated with internal use software are expensed as incurred until certain capitalization criteria are met. Payroll and related costs for employees who are directly associated with, and who devote time to, the development of internal use computer software projects (to the extent time is spent directly on the project) are capitalized. Capitalization begins when the design stage of the application has been completed and it is probable that the project will be completed and used to perform the function intended. Depreciation begins when the software is placed in service. Computer software costs that are capitalized are periodically evaluated for impairment. During the nine months ended September 30, 2011, we wrote off approximately $1,200 (primarily in our International Physical segment) of previously deferred software costs, which were comprised primarily of internal labor costs, associated with internal use software development projects that were discontinued after implementation, which resulted in a loss on disposal/write-down of property, plant and equipment, net in the accompanying consolidated statement of operations.
During the quarter ending September 30, 2011, we disposed of a facility in Canada and recorded a gain of approximately $3,200 which is included in (gain) loss on disposal/write-down of property, plant and equipment, net in our consolidated statement of operations. Additionally, in the quarter ending September 30, 2011, we discontinued the use of certain third-party software licenses, which resulted in a loss of approximately $2,300 (approximately $1,850 associated with our International Physical Business segment and approximately $450 associated with our North American Physical Business segment) included in (gain) loss on disposal/write-down of property, plant and equipment, net in our consolidated statement of operations. Finally, in conjunction with our goodwill impairment analysis associated with our Western Europe reporting unit, we recorded approximately $6,600 of impairments associated with long-lived asset write-downs (primarily racking) as of September 30, 2011 associated with our Italian operations, which is included in (gain) loss on disposal/write-down of property, plant and equipment, net in our consolidated statement of operations.
24
q. Reclassifications
In conjunction with our implementation of a new enterprise management reporting system in the fourth quarter of 2010, we noted inconsistencies in the mapping of certain revenue accounts between storage and service. As a result, we have adjusted previously reported amounts to reduce storage revenues by $7,336 and $21,407 and increase service revenues by a corresponding amount for the three and nine months ended September 30, 2010, respectively. There was no change in total consolidated reported revenues.
(3) Derivative Instruments and Hedging Activities
Every derivative instrument is required to be recorded in the balance sheet as either an asset or a liability measured at its fair value. Periodically, we acquire derivative instruments that are intended to hedge either cash flows or values which are subject to foreign exchange or other market price risk and not for trading purposes. We have formally documented our hedging relationships, including identification of the hedging instruments and the hedged items, as well as our risk management objectives and strategies for undertaking each hedge transaction. Given the recurring nature of our revenues and the long-term nature of our asset base, we have the ability and the preference to use long-term, fixed interest rate debt to finance our business, thereby preserving our long-term returns on invested capital. We target approximately 75% of our debt portfolio to be fixed with respect to interest rates. Occasionally, we may use interest rate swaps as a tool to maintain our targeted level of fixed rate debt. In addition, we may use borrowings in foreign currencies, either obtained in the U.S. or by our foreign subsidiaries, to hedge foreign currency risk associated with our international investments. Sometimes we enter into currency swaps to temporarily hedge an overseas investment, such as a major acquisition, while we arrange permanent financing or to hedge our exposures due to foreign currency exchange movements related to our intercompany accounts with and between our foreign subsidiaries. As of December 31, 2010 and September 30, 2011, none of our derivative instruments contained credit-risk related contingent features.
We have entered into a number of separate forward contracts to hedge our exposures in British pounds sterling, Australian dollars and Canadian dollars. As of September 30, 2011, we had an outstanding forward contract to purchase $201,097 U.S. dollars and sell 125,000 British pounds sterling to hedge our intercompany exposures with Iron Mountain Europe (Group) Limited ("IME"). In the fourth quarter of 2010, we entered into a forward contract to hedge our exposures in Australian dollars. As of September 30, 2011, we had an outstanding forward contract to purchase $77,674 U.S. dollars and sell 72,000 Australian dollars to hedge our intercompany exposures with our Australian subsidiary. Additionally, in the third quarter of 2011, we entered into a forward contract to hedge our exposures in Canadian dollars. As of September 30, 2011, we had an outstanding forward contract to purchase 100,000 Canadian dollars and sell $101,554 U.S. dollars to hedge our intercompany exposures with our Canadian subsidiary. At the maturity of the forward contracts, we may enter into new forward contracts to hedge movements in the underlying currencies. At the time of settlement, we either pay or receive the net settlement amount from the forward contract and recognize this amount in other (income) expense, net in the accompanying statement of operations as a realized foreign exchange gain or loss. At the end of each month, we mark the outstanding forward contracts to market and record an
25
(3) Derivative Instruments and Hedging Activities (Continued)
unrealized foreign exchange gain or loss for the mark-to-market valuation. We have not designated these forward contracts as hedges. During the three and nine months ended September 30, 2010, there were $3,280 in net cash disbursements and $6,726 in net cash receipts, respectively, included in cash from operating activities from continuing operations related to settlements associated with these foreign currency forward contracts. During the three and nine months ended September 30, 2011, there were $68 in net cash receipts and $9,116 in net cash disbursements, respectively, included in cash from operating activities from continuing operations related to settlements associated with these foreign currency forward contracts. The following table provides the fair value of our derivative instruments as of December 31, 2010 and September 30, 2011 and their gains and losses for the three and nine months ended September 30, 2010 and 2011:
Derivatives Not Designated as Hedging Instruments
Foreign exchange contracts
In the third quarter of 2007, we designated a portion of our 63/4% Euro Senior Subordinated Notes due 2018 issued by Iron Mountain Incorporated (the "63/4% Euro Notes") as a hedge of net investment of certain of our Euro denominated subsidiaries. For the nine months ended September 30, 2010 and
26
2011, we designated on average 75,667 and 79,889 Euros, respectively, of the 63/4% Euro Notes as a hedge of net investment of certain of our Euro denominated subsidiaries. As a result, we recorded foreign exchange losses of $10,305 ($6,442, net of tax) and foreign exchange gains $5,331 ($3,332, net of tax) for the three and nine months ended September 30, 2010, respectively, related to the change in fair value of such debt due to currency translation adjustments, which is a component of accumulated other comprehensive items, net included in stockholders' equity. We recorded foreign exchange gains of $11,271 ($7,057, net of tax) and $3,063 ($1,928, net of tax) for the three and nine months ended September 30, 2011, respectively, related to the change in fair value of such debt due to currency translation adjustments, which is a component of accumulated other comprehensive items, net included in stockholders' equity. As of September 30, 2011, net gains of $9,907 are recorded in accumulated other comprehensive items, net associated with this net investment hedge.
(4) Acquisitions
We account for acquisitions using the purchase method of accounting, and, accordingly, the results of operations for each acquisition have been included in our consolidated results from their respective acquisition dates. Cash consideration for our various acquisitions was primarily provided through borrowings under our credit facilities and cash equivalents on-hand. The unaudited pro forma results of operations for the period ended September 30, 2011 are not presented due to the insignificant impact of the 2011 acquisitions on our consolidated results of operations.
In January 2011, we acquired the remaining 80% interest of our joint venture in Poland (Iron Mountain Poland Holdings Limited) in a stock transaction for an estimated purchase price of approximately $80,000, including an initial cash purchase price of $35,000. As a result, we now own 100% of our Polish operations, which provide storage and records management services. The terms of the purchase and sale agreement also required a second payment based upon the audited financial results of the joint venture. This payment of $42,259 was based upon a formula defined in the purchase and sale agreement and was paid in the second quarter of 2011. Additionally, the purchase and sale agreement provides for an escrow hold back of $400 and the payment of up to a maximum of $2,500 of contingent consideration to be paid in July 2012 based upon the satisfaction of certain performance criteria. The carrying value of the 20% interest that we previously held and accounted for under the equity method of accounting amounted to approximately $5,774, and the fair value of such interest on the date of the acquisition of the additional 80% interest was approximately $11,694 and resulted in a gain being recorded to other (income) expense, net of approximately $5,920 during the nine months ended September 30, 2011. The fair value of our previously held equity interest was derived by reducing the total estimated consideration for the 80% equity interest purchased by 40%, which represents management's estimate of the control premium paid, in order to derive the fair value of $11,694 for the 20% noncontrolling equity interest which we previously held. We determined that a 40% control premium was appropriate after considering the size and location of the business acquired, the potential future profits expected to be generated by the Polish entity and publicly available market data. One of the members of our board of directors and several of his family members hold an indirect equity interest in one of the shareholders that received proceeds in connection with this transaction. As a result of this equity interest, such board member, together with several of his family members,
27
(4) Acquisitions (Continued)
received approximately 24% of the purchase price that we paid in connection with this transaction and will receive the same percentage of any future contingent consideration.
A summary of the cumulative consideration paid and the preliminary allocation of the purchase price paid for acquisitions in 2011 through September 30, 2011 is as follows:
Cash Paid (gross of cash acquired)(1)
Contingent Consideration
Fair Value of Previously Held Equity Interest
Total Consideration
Fair Value of Identifiable Assets Acquired:
Cash, Accounts Receivable, Prepaid Expenses and Other
Property, Plant and Equipment(2)
Customer Relationship Assets(3)
Other Assets
Liabilities Assumed(4)
Total Fair Value of Identifiable Net Assets Acquired
Recorded Goodwill
28
(5) Long-term Debt
Long-term debt consists of the following:
IMI Revolving Credit Facility(1)
IMI Term Loan Facility(1)
New Revolving Credit Facility(1)
New Term Loan Facility(1)
71/4% GBP Senior Subordinated Notes due 2014 (the "71/4% notes")(2)(3)
73/4% Senior Subordinated Notes due 2015 (the "73/4% notes due 2015")(2)(3)
65/8% Senior Subordinated Notes due 2016 (the "65/8% notes")(2)(3)
71/2% CAD Senior Subordinated Notes due 2017 (the "Subsidiary Notes")(2)(4)
83/4% Senior Subordinated Notes due 2018 (the "83/4% notes")(2)(3)
8% Senior Subordinated Notes due 2018 (the "8% notes")(2)(3)
63/4% Euro Senior Subordinated Notes due 2018 (the "63/4% notes")(2)(3)
73/4% Senior Subordinated Notes due 2019 (the "73/4% notes due 2019")(2)(3)
8% Senior Subordinated Notes due 2020 (the "8% notes due 2020")(2)(3)
83/8% Senior Subordinated Notes due 2021 (the "83/8% notes")(2)(3)
Real Estate Mortgages, Capital Leases and Other(5)
Total Long-term Debt
Less Current Portion
Long-term Debt, Net of Current Portion
29
(5) Long-term Debt (Continued)
On June 27, 2011, we entered into a new credit agreement to replace the IMI revolving credit facility and the IMI term loan facility, each entered into on April 16, 2007. The new credit agreement consists of (i) revolving credit facilities under which we can borrow, subject to certain limitations as defined in the new credit agreement, up to an aggregate amount of $725,000 (including Canadian dollar, British pound sterling and Euros, among other currencies) (the "New Revolving Credit Facility") and (ii) a $500,000 term loan facility (the "New Term Loan Facility", and collectively with the New Revolving Credit Facility, the "New Credit Agreement"). We have the right to increase the aggregate amount available to be borrowed under the New Credit Agreement up to a maximum of $1,800,000. The New Revolving Credit Facility is supported by a group of 19 banks. IMI, Iron Mountain Information Management, Inc. ("IMIM"), Canada Company, IME, Iron Mountain Australia Pty Ltd., Iron Mountain Switzerland Gmbh and any other subsidiary of IMIM designated by IMIM (the "Other Subsidiaries") may, with the consent of the administrative agent, as defined in the New Credit Agreement, borrow under certain of the following tranches of the New Revolving Credit Facility: (a) tranche one in the amount of $400,000 is available to IMI and IMIM in U.S. dollars, British pound sterling and Euros, (b) tranche two in the amount of $150,000 is available to IMI or IMIM in either U.S. dollars or Canadian dollars and available to Canada Company in Canadian dollars and (c) tranche three in the amount of $175,000 is available to IMI or IMIM and the Other Subsidiaries in U.S. dollars, Canadian dollars, British pounds sterling, Euros and Australian dollars, among others. The New Revolving Credit Facility terminates on June 27, 2016, at which point all revolving credit loans under such facility become due. With respect to the New Term Loan Facility, loan payments are required through maturity on June 27, 2016 in equal quarterly installments of the aggregate annual amounts based upon the following percentage of the original principal amount in the table below (except that
30
each of the first three quarterly installments in the fifth year shall be 10% of the original principal amount and the final quarterly installment in the fifth year shall be 35% of the original principal):
June 30, 2012
June 30, 2013
June 30, 2014
June 30, 2015
June 27, 2016
The New Term Loan Facility may be prepaid without penalty or premium, in whole or in part, at any time. IMI and IMIM guarantee the obligations of each of the subsidiary borrowers. The capital stock or other equity interests of most of the U.S. subsidiaries, and up to 66% of the capital stock or other equity interests of our first-tier foreign subsidiaries, are pledged to secure the New Credit Agreement, together with all intercompany obligations of foreign subsidiaries owed to us or to one of our U.S. subsidiary guarantors. The interest rate on borrowings under the New Credit Agreement varies depending on our choice of interest rate and currency options, plus an applicable margin, which varies based on certain financial ratios. Additionally, the New Credit Agreement requires the payment of a commitment fee on the unused portion of the revolving credit facility, which fee ranges from between 0.3% to 0.5% based on certain financial ratios, as well as fees associated with any outstanding letters of credit. Proceeds from the New Credit Agreement are for general corporate purposes and were used to repay the previous revolving credit and term loan facilities. We recorded a charge of $1,843 to other expense (income), net in the second quarter of 2011 related to the early retirement of the previous revolving credit and term loan facilities, representing a write-off of deferred financings costs. As of September 30, 2011, we had $48,028 of outstanding borrowings under the New Revolving Credit Facility, all of which was denominated in Canadian dollars (CAD 50,000); we also had various outstanding letters of credit totaling $6,013. The remaining availability on September 30, 2011, based on IMI's leverage ratio, which is calculated based on the last 12 months' earnings before interest, taxes, depreciation and amortization ("EBITDA"), and other adjustments as defined in the New Credit Agreement and current external debt, under the New Revolving Credit Facility was $670,959. The interest rate in effect under the New Revolving Credit Facility and New Term Loan Facility was 3.0% and 1.9%, respectively, as of September 30, 2011. For the three and nine months ended September 30, 2010, we recorded commitment fees of $599 and $1,751, respectively, and for the three and nine months ended September 30, 2011, we recorded commitment fees of $613 and $1,465, respectively, based on the unused balances under our revolving credit facilities.
In January 2011, we redeemed the remaining $231,255 aggregate principal amount outstanding of our 73/4% Senior Subordinated Notes due 2015 at a redemption price of one thousand dollars for each one thousand dollars of principal amount of notes redeemed, plus accrued and unpaid interest. We recorded a gain to other expense (income), net of $850 in the first quarter of 2011 related to the early extinguishment of the 73/4% notes being redeemed. This gain consists of original issue premiums, net of deferred financing costs related to the 73/4% notes that were redeemed.
31
In September 2011, we completed an underwritten public offering of $400,000 in aggregate principal amount of our 73/4% Senior Subordinated Notes due 2019, which were issued at 100% of par. Our net proceeds of $394,000 after paying the underwriters' discounts and commissions, will be used for general corporate purposes, including funding a portion of the shareholder payout commitments we have made and possible future acquisitions and investments.
The New Credit Agreement, our indentures and other agreements governing our indebtedness contain certain restrictive financial and operating covenants, including covenants that restrict our ability to complete acquisitions, pay cash dividends, incur indebtedness, make investments, sell assets and take certain other corporate actions. The covenants do not contain a rating trigger. Therefore, a change in our debt rating would not trigger a default under the New Credit Agreement, our indentures or other agreements governing our indebtedness. The New Credit Agreement, as well as our indentures, use EBITDA-based calculations as primary measures of financial performance, including leverage and fixed charge coverage ratios. IMI's revolving credit and term leverage ratio was 2.9 and 3.0 as of December 31, 2010 and September 30, 2011, respectively, compared to a maximum allowable ratio of 5.5. Similarly, our bond leverage ratio, per the indentures, was 3.4 and 3.8 as of December 31, 2010 and September 30, 2011, respectively, compared to a maximum allowable ratio of 6.5. IMI's revolving credit and term loan fixed charge coverage ratio was 1.6 as of September 30, 2011, compared to a minimum allowable ratio of 1.2. Noncompliance with these leverage ratios and the fixed charge coverage ratio would have a material adverse effect on our financial condition and liquidity.
(6) Selected Consolidated Financial Statements of Parent, Guarantors, Canada Company and Non-Guarantors
The following data summarizes the consolidating results of IMI on the equity method of accounting as of December 31, 2010 and September 30, 2011 and for the three and nine months ended September 30, 2010 and 2011.
The Parent Notes and the Subsidiary Notes are guaranteed by the subsidiaries referred to below as the "Guarantors." These subsidiaries are 100% owned by IMI. The guarantees are full and unconditional, as well as joint and several.
32
(6) Selected Consolidated Financial Statements of Parent, Guarantors, Canada Company and Non-Guarantors (Continued)
Additionally, IMI guarantees the Subsidiary Notes, which were issued by Canada Company. Canada Company does not guarantee the Parent Notes. The other subsidiaries that do not guarantee the Parent Notes or the Subsidiary Notes are referred to below as the "Non-Guarantors."
Assets
Cash and Cash Equivalents
Restricted Cash
Accounts Receivable
Intercompany Receivable
Assets of Discontinued Operations (see Note 10)
Other Current Assets
Property, Plant and Equipment, Net
Other Assets, Net:
Long-term Notes Receivable from Affiliates and Intercompany Receivable
Investment in Subsidiaries
Total Other Assets, Net
Liabilities and Equity
Intercompany Payable
Current Portion of Long-term Debt
Total Other Current Liabilities
Liabilities of Discontinued Operations (see Note 10)
Long-term Notes Payable to Affiliates and Intercompany Payable
33
34
Storage
Service
Cost of Sales (Excluding Depreciation and Amortization)
Selling, General and Administrative
Depreciation and Amortization
Intangible Impairments
(Gain) Loss on Disposal/Writedown of Property, Plant and Equipment, Net
Operating (Loss) Income
Interest Expense (Income), Net
(Loss) Income from Continuing Operations Before Provision (Benefit) for Income Taxes
Equity in the Losses (Earnings) of Subsidiaries, Net of Tax
(Loss) Income from Continuing Operations
(Loss) Income from Discontinued Operations (see Note 10)
Net (Loss) Income Attributable to Iron Mountain Incorporated
35
Loss (Gain) on Disposal/Writedown of Property, Plant and Equipment, Net
Other (Income) Expense, Net
Equity in the (Earnings) Losses of Subsidiaries, Net of Tax
Income (Loss) from Discontinued Operations (see Note 10)
Gain (Loss) from Discontinued Operations (see Note 10)
36
37
38
Intercompany loans to subsidiaries
Investment in subsidiaries
Intercompany loans from parent
Equity contribution from parent
Effect of exchange rates on cash and cash equivalents
Increase (Decrease) in cash and cash equivalents
Cash and cash equivalents, beginning of period
Cash and cash equivalents, end of period
39
Payment of debt finacing costs
40
(7) Segment Information
Beginning June 2011, as a result of the disposition of the Digital Business and our decision to sell the New Zealand Business as discussed in Note 10, we changed our reportable segments. The most significant of these changes is that the reportable segment previously referred to as the Worldwide Digital Business is no longer reported separately in our management reporting because the operations associated with the Domain Name Product Line and the Digital Business are reported as discontinued operations. Also, the technology escrow services business, which we continue to own and operate and which was previously reported in the Worldwide Digital Business segment, is now reported as a component of the North American Physical Business segment. Additionally, the International Physical Business segment no longer includes the New Zealand Business because these operations are reported as discontinued operations.
Our operating segments and Corporate are as follows:
41
(7) Segment Information (Continued)
The Latin America, Asia Pacific and Europe operating segments have been aggregated given their similar economic characteristics, products, customers and processes and reported as one reportable segment, "International Physical Business."
An analysis of our business segment information and reconciliation to the consolidated financial statements is as follows:
Three Months Ended September 30, 2010
Depreciations
Amortization
Adjusted OIBDA
Expenditures for Segment Assets
Capital Expenditures
Cash Paid for Acquisitions, Net of Cash acquired
Additions to Customer Relationship and Acquisition Costs
Three Months Ended September 30, 2011
Nine Months Ended September 30, 2010
Total Assets(1)
Nine Months Ended September 30, 2011
42
The accounting policies of the reportable segments are the same as those described in Note 2. Adjusted OIBDA for each segment is defined as operating income before depreciation, amortization, intangible impairments and (gain) loss on disposal/writedown of property, plant and equipment, net which are directly attributable to the segment. Internally, we use Adjusted OIBDA as the basis for evaluating the performance of, and allocating resources to, our operating segments.
A reconciliation of Adjusted OIBDA to income from continuing operations before provision for income taxes on a consolidated basis is as follows:
Less: Depreciation and Amortization
Intangible Impairments (See Note 2.d.)
Interest Expense, Net
Income from Continuing Operations before Provision for Income Taxes
(8) Commitments and Contingencies
We are involved in litigation from time to time in the ordinary course of business. A portion of the defense and/or settlement costs associated with such litigation is covered by various commercial liability insurance policies purchased by us and, in limited cases, indemnification from third parties. Our policy is to establish reserves for loss contingencies when the losses are both probable and estimable. We record legal costs associated with loss contingencies as expenses in the period in which they are incurred. The matters described below represent our significant loss contingencies. We have evaluated each matter and, if both probable and estimable, accrued an amount that represents our estimate of any probable loss associated with such matter. In addition, we have estimated a reasonably possible range for all loss contingencies including those described below. We believe it is reasonably possible that we could incur aggregate losses in addition to amounts currently accrued for all matters up to an additional $33,250 over the next several years.
In July 2006, we experienced a significant fire in a leased records and information management facility in London, England, that resulted in the complete destruction of the facility and its contents. The London Fire Brigade ("LFB") issued a report in which it concluded that the fire resulted either from human agency, i.e., arson, or an unidentified ignition device or source, and its report to the Home
43
(8) Commitments and Contingencies (Continued)
Office concluded that the fire resulted from a deliberate act. The LFB also concluded that the installed sprinkler system failed to control the fire because the primary electric fire pump was disabled prior to the fire and the standby diesel fire pump was disabled in the early stages of the fire by third-party contractors. We have received notices of claims from customers or their subrogated insurance carriers under various theories of liability arising out of lost data and/or records as a result of the fire. Certain of those claims have resulted in litigation in courts in the United Kingdom. We deny any liability in respect of the London fire, and we have referred these claims to our excess warehouse legal liability insurer, which has been defending them to date under a reservation of rights. Certain of the claims have been settled for nominal amounts, typically one to two British pounds sterling per carton, as specified in the contracts, which amounts have been or will be reimbursed to us from our primary property insurer. We believe we carry adequate property and liability insurance related to this incident.
As a result of the February 27, 2010 earthquake in Chile, we experienced damage to certain of our 13 owned and leased records management facilities in that region. None of our facilities were destroyed by fire or significantly impacted by water damage. However, the structural integrity of five buildings was compromised, and some of the racking included in certain buildings was damaged or destroyed. Some customer materials were impacted by this event. Revenues from Chile represent less than 1% of our consolidated enterprise revenues. We believe we carry adequate property and liability insurance and do not expect that this event will have a material impact on our consolidated results of operations or financial condition. We have received approximately $6,800 in payments from our insurance carriers in the first nine months of 2011. Such amount represents final settlement of claims filed with our insurance carriers. We expect to utilize cash from our insurance settlements to fund capital expenditures and for general working capital needs. Our policy related to business interruption insurance recoveries is to record gains within other (income) expense, net in our consolidated statement of operations and proceeds received within cash flows from operating activities in our consolidated statement of cash flows. Such amounts are recorded in the period the cash is received. We recorded approximately $100 within other income (expense), net in our consolidated statement of operations associated with business interruption insurance recoveries in the three months ended September 30, 2011. We have recorded gains on the disposal/write-down of property, plant and equipment, net in our statement of operations of approximately $10,200 for the year ended December 31, 2010 of which $9,368 was recorded in the third quarter of 2010 and the balance in the fourth quarter of 2010. We have reflected approximately $13,000 of the cash proceeds received from our insurers in the nine months ended September 30, 2010 as proceeds from sales of property and equipment, net in our statement of cash flows. Our policy with respect to involuntary conversion of property, plant and equipment is to record any gain or loss within (gain) loss on disposal/writedown of property, plant and equipment, net within operating income in our consolidated statement of operations and proceeds received within cash flows from investing activities within our consolidated statement of cash flows. Losses are recorded when incurred and gains are recorded in the period when the cash received exceeds the carrying value of the related property, plant and equipment.
44
In September 2010, Iron Mountain do Brasil Ltda., our Brazilian operating subsidiary ("IMB"), was sued in Curitiba, Brazil in the 11th Lower Labor Claim Court. The plaintiff in the six related lawsuits, Sindicato dos Trabalhadores em Empresas de Serviços Contábeis, Assessoramento, Perícias, Informações, Pesquisas, e em Empresas Prestadoras de Serviços do Estado do Paraná (Union of Workers in Business Services Accounting, Advice, Expertise, Information, Research and Services Companies in the State of Parana), a labor union in Brazil, purported to represent 2,008 individuals who provided services for IMB. The complaint alleged that these individuals were incorrectly classified as non-employees by IMB and requested unspecified monetary damages, including attorneys' fees, unpaid wages, unpaid benefits and certain penalties. In August 2011, the court approved a settlement between the parties pursuant to which we will pay $2 for each of 531 individuals, subject to each individual's acceptance thereof. If all 531 individuals accept the settlement, it would result in payment by the Company of approximately $1,100. The claims of the remaining 1,477 individuals in the lawsuits not receiving proceeds in the settlement were dismissed by the court.
In August 2010, we were named as a defendant in a patent infringement suit filed in the US District Court for the Eastern District of Texas by Oasis Research, LLC. The plaintiff alleges that the backup technology of Connected Corporation ("Connected") infringes certain U.S. patents owned by the plaintiff and seeks damages equal to 10% of the Connected revenue from 2005 through 2010, or approximately $26,000, and future royalties. A final pre-trial conference has been scheduled for October 12, 2012. We expect the court to establish a trial date during the pre-trial conference. As part of the sale of our Digital Business discussed at Note 10, Autonomy has assumed this obligation and the defense of this litigation and has agreed to indemnify us against any losses.
We have a significant multi-year government contract which covers hard copy, data protection and destruction services that is up for renewal. In conjunction with the renewal process, we have preliminarily determined that our pricing practices under the contract for the last five years resulted in potential overbillings for that time period. Based on our preliminary review, we have reduced reported revenue for the nine months ended September 30, 2011 by $6,000 for the estimated impact of potential pricing adjustments involving this contract.
We are currently under audit by the state of Massachusetts for the 2004 through 2008 tax years. We have not received any assessments to date. However, we received notices of intention to assess totaling $7,867, including interest and penalties, for the tax years 2004 to 2006 related to net worth tax, which is an operating charge and not an income tax charge. We may receive additional notices of intention to assess for tax years subsequent to 2006. We intend to defend this case vigorously and have
45
begun the appeals process with the Massachusetts Department of Revenue Office of Appeals per applicable law and procedure.
(9) Stockholders' Equity Matters
In February 2010, our board of directors approved a share repurchase program authorizing up to $150,000 in repurchases of our common stock, and in October 2010 our board of directors authorized up to an additional $200,000 of such purchases. In May 2011, our board of directors authorized up to an additional $850,000 of such purchases, for a total authorization of $1,200,000. All purchases are subject to stock price, market conditions, corporate and legal requirements and other factors. Additionally, in May 2011, we entered into two prepaid variable share repurchase agreements to repurchase an aggregate of $250,000 of our common stock. In the third quarter of 2011, both prepaid variable share repurchase agreements were settled and 7,539,595 shares were delivered to us and retired. As of September 30, 2011, we had a remaining amount available for repurchase under our share repurchase program of $540,270, which represents approximately 9% in the aggregate of our outstanding common stock based on the closing stock price on such date.
In February 2010, our board of directors adopted a dividend policy under which we intend to pay quarterly cash dividends on our common stock. Declaration and payment of future quarterly dividends is at the discretion of our board of directors. In the first nine months of 2011, our board of directors declared the following dividends:
March 11, 2011
June 10, 2011
September 8, 2011
On March 23, 2011, our board of directors declared a dividend of one preferred stock purchase right ("Right") for each outstanding share of our common stock held by stockholders of record at the close of business on April 1, 2011. Each Right, once exercisable, entitles the registered holder to purchase one one-thousandth of a share of our preferred stock, designated as Series A Junior Participating Preferred Stock, par value $0.01 per share, at a price of $120.00 per one one-thousandth of a share, subject to certain adjustments. No shares of Series A Junior Participating Preferred Stock are outstanding as of September 30, 2011. The Rights will expire upon the close of business on the earliest to occur of: (i) March 22, 2013, (ii) the date on which the Rights are redeemed or exchanged by us in accordance with the rights agreement governing the Rights and (iii) the date of our 2012 annual meeting of stockholders if requisite stockholder approval of the rights agreement is not obtained at such meeting.
46
(10) Discontinued Operations
Digital Operations
In August 2010, we divested the Domain Name Product Line for approximately $11,400 in cash at closing. The assets sold primarily consisted of customer contracts. Total revenues of this product line for the year ended December 31, 2009 and the seven months ended July 31, 2010 were approximately $6,300 and $3,500, respectively. A gain on sale of discontinued operations in the amount of approximately $6,900 ($2,834, net of tax) was recorded during the three months ended September 30, 2010.
During the quarter ended September 30, 2010, we concluded that events occurred and circumstances changed in our former worldwide digital business reporting unit that required us to conduct an impairment review. The primary factors contributing to our conclusion that we had a triggering event and a requirement to reassess our former worldwide digital business reporting unit goodwill for impairment included: (1) a reduction in forecasted revenue and operating results due to continued pressure on key parts of the business as a result of the weak economy; (2) reduced revenue and profit outlook for our eDiscovery service due to smaller average matter size and lower pricing; (3) a decision to discontinue certain software development projects; and (4) the sale of the Domain Name Product Line. As a result of the review, we recorded a provisional goodwill impairment charge associated with our former worldwide digital business reporting unit in the amount of $255,000 during the quarter ended September 30, 2010. We finalized the estimate in the fourth quarter of 2010, and we recorded an additional impairment of $28,785, for a total goodwill impairment charge of $283,785. For the year ended December 31, 2010, we allocated $85,909 of this charge ($76,500 in the third quarter of 2010 and $9,409 in the fourth quarter of 2010) to the retained technology escrow services business, based on a relative fair value basis, which charge continues to be included in our continuing results of operations as a component of intangible impairments in our consolidated statements of operations. As described in Note 7 of the Notes to Consolidated Financial Statements, our technology escrow services business, which had been reported in our former worldwide digital business reporting segment, is now reported as a component of our North American Physical Business segment. In April 2011, we announced a comprehensive strategic plan, which included exploring strategic alternatives for our digital business, including a potential sale of the Digital Business.
On June 2, 2011, IMI completed the sale of our Digital Business to Autonomy, pursuant to the Digital Sale Agreement. In the Digital Sale, Autonomy purchased (i) the shares of certain of IMI's subsidiaries through which IMI conducted our Digital Business and (ii) certain assets of IMI and its subsidiaries relating to our Digital Business. The Digital Sale qualified as discontinued operations because (a) the remaining direct gross cash inflows and outflows of the Digital Business by IMI post-close are not expected to be significant in relation to the direct gross cash inflows and outflows absent the Digital Sale and (b) there is no significant continuing involvement because IMI does not retain the ability to influence the operating and financial policies of the Digital Business. As a result, the financial position, operating results and cash flows of the Digital Business and the Domain Name Product Line, for all periods presented, including the gains on the sales, have been reported as discontinued operations for financial reporting purposes.
47
(10) Discontinued Operations (Continued)
Pursuant to the Digital Sale Agreement, we received approximately $395,400 in cash, consisting of the initial purchase price of $380,000 and a preliminary working capital adjustment of approximately $15,400, which remains subject to a customary post-closing adjustment based on the amount of working capital at closing. The purchase price for the Digital Sale will be increased on a dollar-for-dollar basis if the working capital balance at the time of closing exceeds the target amount of working capital as set forth in the Digital Sale Agreement and decreased on a dollar-for-dollar basis if such closing working capital balance is less than the target amount. We and Autonomy are in disagreement regarding the working capital adjustment in the Digital Sale Agreement. As a result, as contemplated by the Digital Sale Agreement, the matter is being referred to an independent third party accounting firm for determination of the appropriate adjustment amount. Transaction costs amounted to $7,387 ($1,020 of such costs were unpaid as of September 30, 2011). Additionally, $11,075 of inducements are payable to Autonomy and have been netted against the proceeds in calculating the gain on the Digital Sale ($6,000 of such amount was unpaid as of September 30, 2011). We used the net proceeds received from the Digital Sale to pay down amounts outstanding under our revolving credit facility. Also, an estimated tax benefit of $6,734 and tax provision of $45,571 associated with the gain recorded on the Digital Sale was recorded during the three and nine months ended September 30, 2011, respectively. A gain on sale of discontinued operations in the amount of $177 ($6,911, net of tax benefit) and $245,831 ($200,260, net of tax benefit) was recorded during the three and nine month periods ended September 30, 2011, respectively, as a result of the Digital Sale.
The table below summarizes certain results of operations of the Digital Business and the Domain Name Product Line:
Loss Before Benefit for Income Taxes of Discontinued Operations
Benefit for Income Taxes
Loss from Discontinued Operations, Net of Tax
Gain on Sale of Discontinued Operations
Gain on Sale of Discontinued Operations, Net of Tax
Total (Loss) Income from Discontinued Operations and Sale, Net of Tax
48
There have been no allocations of corporate general and administrative expenses to discontinued operations. In accordance with our policy, we have allocated corporate interest associated with all debt that is not specifically allocated to a particular component based on the proportion of the assets of the Digital Business and the Domain Name Product Line to our total consolidated assets at the applicable weighted average interest rate associated with such debt for such reporting period. Interest allocated to the Digital Business and the Domain Name Product Line and included in income (loss) from discontinued operations amounted to $3,584 and $0 for the three months ended September 30, 2010 and 2011, respectively, and $10,752 and $2,396 for the nine months ended September 30, 2010 and 2011, respectively.
The carrying amounts of the major classes of assets and liabilities of the Digital Business were as follows:
Accounts receivable, net
Current assets of discontinued operations
Property, plant and equipment, net
Goodwill, net
Other assets, net
Non-current assets of discontinued operations
Assets of discontinued operations
Current liabilities of discontinued operations
Other long-term liabilities
Non-current liabilities of discontinued operations
Liabilities of discontinued operations
In connection with the Digital Sale, we entered into several other arrangements with Autonomy, including:
49
amounts payable to Autonomy related to qualifying sales of Products and Services to new customers of the Digital Business and are non-refundable to the extent we do not achieve the requisite level of qualifying sales of Products and Services during the term of the reseller agreement.
The revenues and corresponding expenses associated with the above agreements are reflected in our continuing operating results. None of these services gives us the ability to influence the operating and financial policies of the Digital Business. We have concluded that the direct cash flows associated with these agreements are not significant because they are estimated to represent less than 5% of both direct cash inflows and outflows of the Digital Business for the one-year period subsequent to the Digital Sale, and, therefore, we have reported the Digital Business as discontinued operations in the accompanying consolidated financial statements for all periods presented. We will continue to assess the cash flows associated with these agreements and our conclusion that the Digital Business be reported as discontinued operations until the first anniversary of the Digital Sale.
New Zealand Business
After further analysis subsequent to our April 2011 announcement of our comprehensive strategic plan, which includes reviewing select underperforming international markets, we committed in May 2011 to a plan to sell the New Zealand Business. During the second quarter of 2011, we recorded an impairment charge of $4,900 to write-down the long-lived assets of the New Zealand Business to its estimated net realizable value which is included in income (loss) from discontinued operations. In the calculation of the carrying value of the New Zealand Business, we allocated the goodwill of our Australia/New Zealand reporting unit between Australia and New Zealand on a relative fair value basis. Additionally, we recorded a tax benefit of $7,606 during the nine months ended September 30, 2011 associated with the outside tax basis of the New Zealand Business, which is also reflected in income (loss) from discontinued operations. No valuation allowance was provided against this benefit because such amount is recoverable against the capital gain associated with the Digital Sale. We completed the sale of the New Zealand Business on October 3, 2011 for a purchase price of approximately $10,000, which remains subject to a customary post-closing adjustment based on the amount of working capital at closing. The purchase price for the New Zealand Business will be increased on a dollar-for-dollar basis if the working capital balance at the time of closing exceeds the target amount of working capital as set forth in the purchase and sale agreement and decreased on a
50
dollar-for-dollar basis if such closing working capital balance is less than the target amount. We anticipate recording a gain on the sale of discontinued operations associated with the New Zealand Business in the amount of approximately $1,800 during the fourth quarter of 2011. The New Zealand Business was previously included within the International Physical Business segment. Beginning in the second quarter of 2011, the New Zealand Business has been classified as held for sale and, for all periods presented, the financial position, operating results and cash flows of the New Zealand Business have been reported as discontinued operations for financial reporting purposes.
The table below summarizes certain results of operations of the New Zealand Business:
Income (Loss) Before Provision (Benefit) for Income Taxes of Discontinued Operations
Income (Loss) from Discontinued Operations, Net of Tax
Gain (Loss) on Sale of Discontinued Operations
Provision for Income Taxes
Gain (Loss) on Sale of Discontinued Operations, Net of Tax
Total Income (Loss) from Discontinued Operations and Sale, Net of Tax
51
The carrying amounts of the major classes of assets and liabilities of the New Zealand Business were as follows:
(11) Subsequent Events
We experienced a fire at a facility we lease in Aprilla, Italy on November 4, 2011. All employees were evacuated safely and the cause of the fire is currently being investigated. The facility primarily stored archival and inactive business records for local area businesses.
The leased facility, constructed in 2004, is one of approximately 1,000 facilities in our global portfolio and one of 10 facilities located in Italy. Despite quick response by local fire authorities, damage to the building was extensive and the building appears to be a total loss. We believe we carry adequate insurance and are in the process of assessing the impact of the fire but do not expect that this event will have a material impact to our consolidated results of operations or financial condition. Revenues from our operations in Aprilla, Italy represent less than 0.5% of our consolidated revenues.
52
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of our financial condition and results of operations for the three and nine months ended September 30, 2011 should be read in conjunction with our Consolidated Financial Statements and Notes thereto for the three and nine months ended September 30, 2011, included herein, and for the year ended December 31, 2010, included in our Current Report on Form 8-K dated September 19, 2011.
FORWARD-LOOKING STATEMENTS
We have made statements in this Quarterly Report on Form 10-Q that constitute "forward-looking statements" as that term is defined in the Private Securities Litigation Reform Act of 1995 and other federal securities laws. These forward-looking statements concern our operations, economic performance, financial condition, goals, beliefs, future growth strategies, investment objectives, plans and current expectations, such as the impairment charges associated with our Western Europe operations and our intent and ability to repurchase shares and pay dividends. The forward-looking statements are subject to various known and unknown risks, uncertainties and other factors. When we use words such as "believes," "expects," "anticipates," "estimates" or similar expressions, we are making forward-looking statements. Although we believe that our forward-looking statements are based on reasonable assumptions, our expected results may not be achieved, and actual results may differ materially from our expectations. Important factors that could cause actual results to differ from expectations include, among others: (1) the cost to comply with current and future laws, regulations and customer demands relating to privacy issues; (2) the impact of litigation or disputes that may arise in connection with incidents in which we fail to protect our customers' information; (3) changes in the price for our services relative to the cost of providing such services; (4) changes in customer preferences and demand for our services; (5) the cost or potential liabilities associated with real estate necessary for our business; (6) the performance of business partners upon whom we depend for technical assistance or management expertise outside the U.S.; (7) changes in the political and economic environments in the countries in which our international subsidiaries operate; (8) claims that our technology violates the intellectual property rights of a third party; (9) the impact of legal restrictions or limitations under stock repurchase plans on price, volume or timing of stock repurchases; (10) the impact of alternative, more attractive investments on dividends or stock repurchases; (11) our ability or inability to complete acquisitions on satisfactory terms and to integrate acquired companies efficiently; and (12) other trends in competitive or economic conditions affecting our financial condition or results of operations not presently contemplated. You should not rely upon forward-looking statements except as statements of our present intentions and of our present expectations, which may or may not occur. Other risks may adversely impact us, as described more fully under "Item 1A. Risk Factors" in our Quarterly Report on Form 10-Q for the quarter ended March 31, 2011 and Current Reports on Form 8-K dated September 19, 2011. You should read these cautionary statements as being applicable to all forward-looking statements wherever they appear. Except as required by law, we undertake no obligation to release publicly the result of any revision to these forward-looking statements that may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. Readers are also urged to carefully review and consider the various disclosures we have made in this document, as well as our other periodic reports filed with the Securities and Exchange Commission ("SEC").
53
Non-GAAP Measures
Adjusted Operating Income Before Depreciation, Amortization and Intangible Impairments ("Adjusted OIBDA")
Adjusted OIBDA is defined as operating income before depreciation, amortization, intangible impairments and (gain) loss on disposal/write-down of property, plant and equipment, net. Adjusted OIBDA Margin is calculated by dividing Adjusted OIBDA by total revenues. We use multiples of current or projected Adjusted OIBDA in conjunction with our discounted cash flow models to determine our overall enterprise valuation and to evaluate acquisition targets. We believe Adjusted OIBDA and Adjusted OIBDA Margin provide current and potential investors with relevant and useful information regarding our ability to generate cash flow to support business investment. These measures are an integral part of the internal reporting system we use to assess and evaluate the operating performance of our business. Adjusted OIBDA does not include certain items that we believe are not indicative of our core operating results, specifically: (1) (gain) loss on disposal/write-down of property, plant and equipment, net; (2) intangible impairments; (3) other expense (income), net; (4) cumulative effect of change in accounting principle; (5) income (loss) from discontinued operations; (6) gain (loss) on sale of discontinued operations; and (7) net income (loss) attributable to noncontrolling interests.
Adjusted OIBDA also does not include interest expense, net and the provision (benefit) for income taxes. These expenses are associated with our capitalization and tax structures, which we do not consider when evaluating the operating profitability of our core operations. Finally, Adjusted OIBDA does not include depreciation and amortization expenses in order to eliminate the impact of capital investments, which we evaluate by comparing capital expenditures to incremental revenue generated and as a percentage of total revenues. Adjusted OIBDA and Adjusted OIBDA Margin should be considered in addition to, but not as a substitute for, other measures of financial performance reported in accordance with accounting principles generally accepted in the United States of America ("GAAP"), such as operating or net income (loss) or cash flows from operating activities from continuing operations (as determined in accordance with GAAP).
Reconciliation of Adjusted OIBDA to Operating Income; Income from Continuing Operations and Net Income (Loss) (in thousands):
Operating Income
Less: Interest Expense, Net
Income from Continuing Operations
Total (Loss) Income from Discontinued Operations
Net Income Attributable to Noncontrolling interests
54
Free Cash Flows before Acquisitions and Discretionary Investment ("FCF")
FCF is defined as Cash Flows from Operating Activities from continuing operations less capital expenditures (excluding real estate), net of proceeds from the sales of property and equipment and other, net and additions to customer relationship and acquisition costs. Our management uses this measure when evaluating the operating performance of our consolidated business. We believe this measure provides relevant and useful information to our current and potential investors. FCF is a useful measure in determining our ability to generate excess cash that may be used for reinvestment in the business, discretionary deployment in investments such as real estate or acquisition opportunities, returning of capital to our shareholders and voluntary prepayments of indebtedness. FCF reconciled to Cash Flows from Operating Activities from Continuing Operations (in thousands):
Free Cash Flows before Acquisitions and Discretionary Investments
Add: Capital Expenditures (excluding real estate), net
Additions to Customer Acquisitions Costs
Cash Flows From Operating Activities—Continuing Operations
Cash Flows From Investing Activities—Continuing Operations
Cash Flows From Financing Activities—Continuing Operations
Adjusted Earnings per Share ("Adjusted EPS")
Adjusted EPS is defined as reported earnings per share from continuing operations excluding: (a) (gain) loss on the disposal/write-down of property, plant and equipment, net; (b) intangible impairment charges; (c) other expense (income), net; and (d) the tax impact of reconciling items and discrete tax items. We do not believe these excluded items to be indicative of our ongoing operating results, and they are not considered when we are forecasting our future results. We believe Adjusted EPS from continuing operations is of value to investors when comparing our results from past, present and future periods.
Adjusted EPS—Fully Diluted from Continuing Operations reconciled to Reported EPS Fully Diluted from Continuing Operations:
Adjusted EPS—Fully Diluted from Continuing Operations
Less: (Gain) Loss on disposal/write-down of property, plant and equipment, net
Other (Income) Expense, net
Tax impact of reconciling items and discrete tax items
Reported EPS—Fully Diluted from Continuing Operations
Critical Accounting Policies
Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with GAAP. The
55
preparation of these financial statements requires us to make estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities at the date of the financial statements and for the period then ended.
On an on-going basis, we evaluate the estimates used. We base our estimates on historical experience, actuarial estimates, current conditions and various other assumptions that we believe to be reasonable under the circumstances. These estimates form the basis for making judgments about the carrying values of assets and liabilities and are not readily apparent from other sources. Actual results may differ from these estimates. Our critical accounting policies include the following, which are listed in no particular order:
Further detail regarding our critical accounting policies can be found in "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Current Report on Form 8-K and the consolidated financial statements and the notes included therein dated September 19, 2011. Management has determined that no material changes concerning our critical accounting policies have occurred since December 31, 2010.
Recent Accounting Pronouncements
In July 2011, the Financial Accounting Standards Board (the "FASB") issued amended guidance that revises the manner in which entities present comprehensive income in their financial statements. The new guidance removes the presentation options currently available in Accounting Standards Codification ("ASC") 220 and requires entities to report components of comprehensive income in either (1) a continuous statement of comprehensive income or (2) two separate but consecutive statements. Under the two-statement approach, the first statement would include components of net income, which is consistent with the income statement format used currently under ASC 220, and the second statement would include components of other comprehensive income ("OCI"). Under either method, entities must display adjustments for items that are reclassified from OCI to net income in both net income and OCI. The amended guidance does not change the current option for entities to present components of OCI gross or net of the effect of income taxes, provided that such tax effects are presented in the statement in which OCI is presented or disclosed in the notes to the financial statements. The amended guidance does not change the items that must be reported in OCI. The amendments are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011 and must be applied retrospectively for all periods presented in the financial statements. Early adoption of the amended guidance is permitted; however, we do not intend to early adopt. Adoption is not expected to have a material impact on our consolidated financial statements or results of operations.
56
Overview
The following discussions set forth, for the periods indicated, management's discussion and analysis of results. Significant trends and changes for the three and nine month periods ended September 30, 2011 are discussed within each section. Trends and changes that are consistent within the three and nine month periods are not repeated and are discussed on a year-to-date basis.
Prior to January 1, 2010, the financial position and results of operations of the operating subsidiaries of Iron Mountain Europe (Group) Limited (collectively referred to as "IME"), our European business, were consolidated based on IME's fiscal year ended October 31. Effective January 1, 2010, we changed the fiscal year-end (and the reporting period for consolidation purposes) of IME to coincide with the fiscal year-end of Iron Mountain Incorporated ("IMI"), which is December 31. We believe that the change in accounting principle related to the elimination of the two-month reporting lag for IME is preferable because it results in more contemporaneous reporting of events and results related to IME. In accordance with applicable accounting literature, a change in a subsidiary's year-end is treated as a change in accounting principle and requires retrospective application. The impact of the change was not material to the results of operations for the previously reported annual and interim periods prior to January 1, 2010, and, thus, those results have not been revised. There is, however, a charge of $4.7 million recorded to other (income) expense, net in the year ended December 31, 2010 to recognize the immaterial differences arising from the change.
In August 2010, we divested the domain name management product line (the "Domain Name Product Line") of our digital business. On June 2, 2011, we completed the sale (the "Digital Sale") of our online backup and recovery, digital archiving and eDiscovery solutions businesses (the "Digital Business") to Autonomy Corporation plc, a corporation formed under the laws of England and Wales ("Autonomy"), pursuant to a purchase and sale agreement dated as of May 15, 2011 among IMI, certain subsidiaries of IMI and Autonomy (the "Digital Sale Agreement"). In the Digital Sale, Autonomy purchased (i) the shares of certain of IMI's subsidiaries through which IMI conducted the Digital Business and (ii) certain assets of IMI and its subsidiaries relating to the Digital Business. The Digital Sale qualified as discontinued operations and the financial position, operating results and cash flows, for all periods presented in this Quarterly Report on Form 10-Q, including the gain on the sale, have been reported as discontinued operations for financial reporting purposes. IMI retained its technology escrow services business which had previously been reported in the former Worldwide Digital Business segment along with the Digital Business and the Domain Name Product Line. The technology escrow services business is now reported in the North American Physical Business segment. Additionally, in May 2011, we committed to a plan to sell our records management business in New Zealand (the "New Zealand Business"). The New Zealand Business was sold on October 3, 2011. The financial position, operating results and cash flows of the New Zealand Business, for all periods presented, have been reported as discontinued operations for financial reporting purposes. See "Note 10. Discontinued Operations" of the Notes to Consolidated Financial Statements.
In September 2011, as a result of certain changes we made in the manner in which our European operations will be managed, we reorganized our reporting structure and reassigned goodwill among the revised reporting units. As a result of the management and reporting changes, we concluded that we have three reporting units for our European operations: (1) the United Kingdom, Ireland and Norway ("UKI"), (2) Belgium, France, Germany, Italy, Luxembourg, Netherlands and Spain ("Western Europe") and (3) the remaining countries in Europe ("Central Europe"). Due to these changes, we will perform all future goodwill impairment analysis on the new reporting unit basis. As a result of the restructuring of our reporting units, we concluded that we had an interim triggering event, and, therefore, we performed an interim goodwill impairment test for UKI, Western Europe and Central Europe in the third quarter of 2011. As required by GAAP, prior to our goodwill impairment analysis we performed an impairment test on the long-lived assets within our Western Europe reporting unit. The undiscounted cash flows from our Italian operations were lower than the carrying value of the
57
long-lived assets associated with these operations and resulted in the requirement to fair value the long-lived assets of this lower level component. As a result, we recorded write-offs of other intangible assets, primarily customer relationship values, of $8.0 million during the quarter ending September 30, 2011, associated with our Italian operations which are a component of our Western Europe reporting unit. Additionally, we recorded approximately $6.6 million of impairments associated with long-lived asset write-downs (primarily racking) as of September 30, 2011 associated with our Italian operations, which is included in (gain) loss on disposal/write-down of property, plant and equipment, net in our consolidated statement of operations. Based on our analyses, we concluded that the goodwill of our UKI and Central Europe reporting units were not impaired. Our UKI and Central Europe reporting units have fair values that exceed their carrying values by 15.1% and 5.0%, respectively, as of August 31, 2011. Central Europe is still in the investment stage and accordingly its fair value does not exceed its carrying value by a significant margin at this point in time. A deterioration of the UKI or Central Europe businesses or the businesses not achieving the forecasted results could lead to impairments in future periods. Our Western Europe reporting unit's fair value was less than its carrying value, and, as a result, we recorded a provisional goodwill impairment charge included as a component of intangible impairments in our consolidated statements of operations for the quarter ending September 30, 2011 of $45.0 million. An estimated tax benefit of approximately $6.5 million was recorded associated with the Western Europe provisional goodwill impairment charge. The provisional charge is subject to refinement of forecast assumptions and results and valuation analyses necessary to calculate an implied fair value for goodwill. After the provisional impairment, the remaining Western Europe reporting unit goodwill is $52.6 million. We will finalize the provisional charge and record any necessary adjustments in the fourth quarter of 2011 (including to the estimated tax benefit).
Our revenues consist of storage revenues as well as service revenues. Storage revenues, which are considered a key performance indicator for the information management services industry, consist primarily of recurring periodic charges related to the storage of materials or data (generally on a per unit basis), that are typically retained by customers for many years. Service revenues are comprised of charges for related core service activities and a wide array of complementary products and services. Included in core service revenues are: (1) the handling of records, including the addition of new records, temporary removal of records from storage, refiling of removed records and destruction of records; (2) courier operations, consisting primarily of the pickup and delivery of records upon customer request; (3) secure shredding of sensitive documents; and (4) other recurring services, including hybrid services and recurring project revenues. Our complementary services revenues include special project work, customer termination and permanent withdrawal fees, data restoration projects, fulfillment services, consulting services, technology services and product sales (including specially designed storage containers and related supplies). Our secure shredding revenues include the sale of recycled paper (included in complementary services revenues), the price of which can fluctuate from period to period, adding to the volatility and reducing the predictability of that revenue stream. In conjunction with our implementation of a new enterprise management reporting system in the fourth quarter of 2010, we noted inconsistencies in the mapping of certain revenue accounts between storage and service. As a result, we have adjusted previously reported amounts to reduce storage revenues by approximately $7.3 million and $21.4 million and increase service revenues by a corresponding amount for the three and nine months ended September 30, 2010, respectively. There was no change in total consolidated reported revenues and the changes were not material to internal revenue growth calculations.
Cost of sales (excluding depreciation and amortization) consists primarily of wages and benefits for field personnel, facility occupancy costs (including rent and utilities), transportation expenses (including vehicle leases and fuel), other product cost of sales and other equipment costs and supplies. Of these, wages and benefits and facility occupancy costs are the most significant. Trends in total wages and benefits in dollars and as a percentage of total consolidated revenue are influenced by changes in headcount and compensation levels, achievement of incentive compensation targets, workforce
58
productivity and variability in costs associated with medical insurance and workers compensation. Trends in facility occupancy costs are impacted by the total number of facilities we occupy, the mix of properties we own versus properties we occupy under operating leases, fluctuations in per square foot occupancy costs, and the levels of utilization of these properties.
The expansion of our European and secure shredding businesses has impacted the major cost of sales components. Our European operations are more labor intensive than our core U.S. physical businesses and, therefore, add incremental labor costs at a higher percentage of segment revenue than our North American core physical business. Our secure shredding operations incur lower facility costs and higher transportation costs as a percentage of revenues compared to our core physical businesses.
Selling, general and administrative expenses consist primarily of wages and benefits for management, administrative, information technology, sales, account management and marketing personnel, as well as expenses related to communications and data processing, travel, professional fees, bad debts, training, office equipment and supplies. Trends in total wage and benefit dollars as a percentage of total consolidated revenue are influenced by changes in headcount and compensation levels, achievement of incentive compensation targets, workforce productivity and variability in costs associated with medical insurance. The overhead structure of our expanding European and Asian operations, as compared to our North American operations, is more labor intensive and has not achieved the same level of overhead leverage, which may result in an increase in selling, general and administrative expenses, as a percentage of consolidated revenue, as our European and Asian operations become a more meaningful percentage of our consolidated results.
Our depreciation and amortization charges result primarily from the capital-intensive nature of our business. The principal components of depreciation relate to storage systems, which include racking, building and leasehold improvements, computer systems hardware and software, and buildings. Amortization relates primarily to customer relationship acquisition costs and core technology and is impacted by the nature and timing of acquisitions.
Our consolidated revenues and expenses are subject to variations caused by the net effect of foreign currency translation on revenues and expenses incurred by our entities outside the U.S. It is difficult to predict how much foreign currency exchange rates will fluctuate in the future and how those fluctuations will impact our consolidated statement of operations. Due to the expansion of our international operations, these fluctuations have become material on individual balances. However, because both the revenues and expenses are denominated in the local currency of the country in which they are derived or incurred, the impact of currency fluctuations on our operating income and operating margin is mitigated. In order to provide a framework for assessing how our underlying businesses performed excluding the effect of foreign currency fluctuations, we compare the percentage change in the results from one period to another period in this report using constant currency disclosure. The constant currency growth rates are calculated by translating the 2010 results at the 2011 average exchange rates.
The following table is a comparison of underlying average exchange rates of the foreign currencies that had the most significant impact on our U.S. dollar-reported revenues and expenses:
British pound sterling
Canadian dollar
Euro
59
Results of Operations
Comparison of Three and Nine Months Ended September 30, 2011 to Three and Nine Months Ended September 30, 2010 (in thousands):
Revenues
Operating Expenses(1)
Other Expenses, Net
Income from Continuing Operations(1)
Loss from Discontinued Operations
Net Income Attributable to Noncontrolling Interests
Adjusted OIBDA(2)
Adjusted OIBDA Margin(2)
60
61
REVENUES
Core Service
Total Core Revenue
Complementary Services
Total Revenue
Our consolidated storage revenues increased $25.1 million, or 6.2%, to $428.7 million and increased $66.4 million, or 5.5%, to $1,266.4 million for the three and nine months ended September 30, 2011, respectively, from $403.7 million and $1,200.0 million for the three and nine months ended September 30, 2010, respectively. The increase is attributable to internal revenue growth of 3.3% and 3.0% for the three and nine month periods ended September 30, 2011, respectively. Foreign currency exchange rate fluctuations added approximately 2.1% to our storage revenue growth rate for both the three and nine month periods ended September 30, 2011. Net acquisitions/divestitures contributed 0.8% and 0.4% of the increase in reported storage revenues in the three and nine month periods ended September 30, 2011, respectively, compared to the same periods in 2010. Our storage growth rate in the first nine months of 2011 was driven by continued solid storage growth in the International Physical Business segment and consistent volume and price trends in our North American Physical Business segment.
Consolidated service revenues consisting of core service and complementary services increased $15.9 million, or 4.8%, to $343.3 million and increased $37.4 million, or 3.8%, to $1,018.9 million for the three and nine months ended September 30, 2011, respectively, from $327.5 million and $981.4 million for the three and nine months ended September 30, 2010, respectively. Service revenue internal growth was 1.6% and 0.8% for the three and nine month periods ended September 30, 2011, respectively. The service revenue internal growth for the three months ended September 30, 2011 was driven by complementary service revenue internal growth of 8.9%, partially offset by negative core service internal growth of 1.1% due to lower core service activity levels, particularly with respect to transportation, retrieval/refiles and data protection handling. The service revenue internal growth for
62
the nine months ended September 30, 2011 was driven by complementary service revenue internal growth of 5.0%, partially offset by negative core service internal growth of 0.7%. Complementary service revenues increased in the three and nine months ended September 30, 2011 compared to the same periods in 2010, primarily due to $11.0 million and $24.4 million, respectively, of additional revenues generated from the sale of recycled paper due to increases in paper prices. Core service revenue internal growth in the three and nine months ended September 30, 2011 was constrained by consistent economic trends and pressures on activity-based service revenues related to the handling and transportation of items in storage. These decreases were partially offset by strong hybrid revenue growth and higher fuel surcharges. Foreign currency exchange rate fluctuations increased reported service revenues by 2.5% for both the three and nine months ended September 30, 2011 over the same periods in 2010. Net acquisitions/divestitures contributed 0.7% and 0.5% of the increase in reported service revenues in the three and nine months ended September 30, 2011 compared to the same periods in 2010.
For the reasons stated above, our consolidated revenues increased $41.0 million, or 5.6%, to $772.1 million for the three months ended and increased $103.8 million, or 4.8%, to $2,285.3 million for the nine months ended September 30, 2011, respectively, from $731.1 million and $2,181.5 million for the three and nine months ended September 30, 2010, respectively. During the nine months ended September 30, 2011, we recorded a $6.0 million reduction to reported revenues related to a pricing adjustment involving a government contract. Internal growth calculations for 2011 exclude this adjustment. Internal revenue growth was 2.5% and 2.0% for the three and nine months ended September 30, 2011, respectively. We calculate internal revenue growth in local currency for our international operations. For the three and nine months ended September 30, 2011, foreign currency exchange rate fluctuations increased our consolidated revenues by 2.3%, primarily due to the strengthening of the British pound sterling, Canadian dollar and Euro against the U.S. dollar, based on an analysis of weighted average rates for the comparable periods. Net acquisition/divestitures contributed 0.8% and 0.5% of the increase in total reported revenues in the three and nine months ended September 30, 2011 compared to the same periods in 2010.
Internal Growth—Eight-Quarter Trend
Storage Revenue
Service Revenue
During the past eight quarters our storage internal growth rate has ranged between 2.2% and 5.5%. Our storage growth rate moderated in late 2009 and into 2010 due to the economic downturn, which resulted in reduced average net pricing gains in the North American records management business due to the low inflationary environment, episodic destructions in the physical data protection business and lower new sales and higher destruction rates in our North American records management business. These impacts were offset by new sales in international markets. Our storage growth rate in 2011 was driven by continued solid storage growth in the International Physical Business segment and sustained growth in our North American records management business. The internal growth rate for service revenue is inherently more volatile than the storage revenue internal growth rate due to the more discretionary nature of certain complementary services we offer, such as large special projects and the volatility of prices for recycled paper. These revenues, which are often event-driven and impacted to a greater extent by economic downturns as customers defer or cancel the purchase of certain services as a way to reduce their short-term costs, may be difficult to replicate in future periods. As a commodity, recycled paper prices are subject to the volatility of that market. The internal growth rate
63
for service revenues reflects the following: (1) pressures on activity-based service revenues related to the handling and transportation of items in storage and secure shredding; (2) the expected softness in our complementary service revenues, such as project revenues and fulfillment services; and (3) improvement in commodity prices for recycled paper and higher fuel surcharges.
OPERATING EXPENSES
Cost of Sales
Consolidated cost of sales (excluding depreciation and amortization) is comprised of the following expenses (in thousands):
Labor
Facilities
Transportation
Product Cost of Sales and Other
Labor expense decreased to 19.5% of consolidated revenues in the nine months ended September 30, 2011 compared to 20.3% in the comparable prior year period. For the nine month period ended September 30, 2011, labor expense was unfavorably impacted by 2.6 percentage points due to currency rate changes. Excluding (1) the effect of currency rate fluctuations and (2) the impact associated with labor cost accruals related to the Brazilian litigation in which a charge of $7.4 million was recorded in the three months ending September 30, 2010 and a benefit of $3.5 million was recorded in the three months ending September 30, 2011, labor expense for the three and nine months ended September 30, 2011 increased by 1.3% and 0.5%, respectively, compared to the three and nine months ended September 30, 2010.
Facilities costs increased to 14.2% of consolidated revenues in the nine months ended September 30, 2011 compared to 14.1% in the comparable prior year period. Facilities costs were unfavorably impacted by 2.4 percentage points due to currency rate changes during the nine months ended September 30, 2011. The largest component of our facilities cost is rent expense, which, in constant currency terms, increased by $0.6 million to $161.6 million for the nine months ended September 30, 2011 compared to the same period of 2010. Other facilities costs increased by
64
approximately $8.1 million, in constant currency terms, for the nine months ended September 30, 2011 compared to the nine months ended September 30, 2010, primarily due to increased building maintenance costs of $9.8 million.
Transportation expenses were unfavorably impacted by 2.8 percentage points due to currency rate changes during the nine months ended September 30, 2011. Transportation expenses increased by $13.0 million in constant currency terms during the nine months ended September 30, 2011 compared to the same period in 2010. The increase in transportation costs was a result of increased third party transportation costs of $5.8 million, increased fuel costs of $5.1 million and increased vehicle repair costs of $0.9 million.
Product cost of sales and other, which includes cartons, media and other service, storage and supply costs, is highly correlated to complementary revenue streams. These costs were unfavorably impacted by 2.9 percentage points due to currency rate changes during the nine months ended September 30, 2011. For the nine months ended September 30, 2011, product cost of sales and other increased by $1.4 million as compared to the prior year on an actual basis.
Selling, General and Administrative Expenses
Selling, general and administrative expenses are comprised of the following expenses (in thousands):
General and Administrative
Sales, Marketing & Account Management
Information Technology
Bad Debt Expense
65
General and administrative expenses increased to 16.1% of consolidated revenues during the nine months ended September 30, 2011 compared to 15.4% in the comparable prior year period. General and administrative expenses were unfavorably impacted by 2.4 percentage points due to currency rate changes during the first nine months of 2011. In constant currency terms, general and administrative expenses increased by $24.9 million during the nine months ended September 30, 2011 compared to the same period in 2010. The increase was primarily attributable to $15.0 million of advisory fees and other costs associated with our recent proxy contest and a $10.3 million increase in incentive compensation.
Sales, marketing and account management expenses were unfavorably impacted by 2.7 percentage points due to currency rate changes during the nine months ended September 30, 2011. In constant currency terms, the increase of $25.9 million during the nine months ended September 30, 2011 is primarily related to increased sales and marketing within North America, which resulted in increased compensation of $21.0 million, primarily due to increased sales commissions, payroll tax expenses and incentive compensation.
Information technology expenses were unfavorably impacted by 2.4 percentage points due to currency rate changes during the nine months ended September 30, 2011. In constant currency terms, information technology expenses increased $11.8 million during the nine months ended September 30, 2011 compared to the same period in 2010 due to an increase in incentive compensation of $4.4 million and payroll taxes of $2.5 million, in addition to an increase in technology maintenance and support costs of $5.4 million.
Consolidated bad debt expense for the nine months ended September 30, 2011 decreased $2.0 million, or 19.5%, to $8.4 million (0.4% of consolidated revenues) compared to $10.4 million (0.5% of consolidated revenues) in the same period in 2010. We maintain an allowance for doubtful accounts that is calculated based on our past loss experience, current and prior trends in our aged receivables, current economic conditions, and specific circumstances of individual receivable balances. We continue to monitor our customers' payment activity and make adjustments based on their financial condition and in light of historical and expected trends.
Depreciation, Amortization, and (Gain) Loss on Disposal/Write-down of Property, Plant and Equipment, Net
Depreciation expense decreased $0.3 million and increased $7.9 million for the three and nine months ended September 30, 2011, respectively, compared to the three and nine months ended September 30, 2010. The increase in depreciation for the nine months ended September 30, 2011 was primarily due to additional depreciation expense related to capital expenditures and acquisitions, including storage systems, which include racking, building and leasehold improvements, computer systems, hardware and software, and buildings primarily in our International Physical Business segment.
Amortization expense increased $0.9 million and $2.4 million for the three and nine months ended September 30, 2011, respectively, compared to the three and nine months ended September 30, 2010, primarily due to amortization of customer relationship intangible assets acquired related to the Poland acquisition described in Note 4 of the Notes to Consolidated Financial Statements.
66
Consolidated loss on disposal/write-down of property, plant and equipment, net of $5.1 million for the nine months ended September 30, 2011, consisted primarily of: (a) an impairment of $6.6 million associated with long-lived asset write-downs (primarily racking) associated with our Italian operations in conjunction with the goodwill impairment analysis associated with our Western Europe reporting unit discussed at Note 2.d. and 2.p. to the Notes to the Consolidated Financial Statements; (b) a loss of approximately $2.3 million associated with our discontinuing the use of certain third-party software licenses (approximately $1.9 million associated with our International Physical Business segment and approximately $0.4 million associated with our North American Physical Business segment); (c) a loss of $1.2 million on previously deferred software costs related to our International Physical Business segment associated with certain software development projects that were discontinued after implementation; (d) $0.6 million of write-offs associated with other asset dispositions in our North American Physical Business segment, offset by (e) a gain of $3.2 million associated with the disposition of a facility in Canada and (f) $1.2 million of gains related primarily to vehicle dispositions in North America. Consolidated gain on disposal/write-down of property, plant and equipment, net of $10.5 million for the nine months ended September 30, 2010, consisted primarily of a gain of $9.4 million as a result of the settlement with our insurers in connection with a portion of the property component of our claim related to the Chilean earthquake in the third quarter of 2010 and gains of $3.2 million in North America on the disposition of certain owned equipment, offset by $2.0 million of impairment losses primarily related to certain owned facilities in North America.
During the quarter ended September 30, 2010, we concluded that events occurred and circumstances changed in our former worldwide digital business reporting unit that required us to conduct an impairment review. The primary factors contributing to our conclusion that we had a triggering event and a requirement to reassess our former worldwide digital business reporting unit goodwill for impairment included: (1) a reduction in forecasted revenue and operating results due to continued pressure on key parts of the business as a result of the weak economy; (2) reduced revenue and profit outlook for our eDiscovery service due to smaller average matter size and lower pricing; (3) a decision to discontinue certain software development projects; and (4) the sale of the Domain Name Product Line. As a result of the review, we recorded a provisional goodwill impairment charge associated with our former worldwide digital business reporting unit in the amount of $255.0 million during the quarter ended September 30, 2010. We finalized the estimate in the fourth quarter of 2010, and we recorded an additional impairment of $28.8 million, for a total goodwill impairment charge of $283.8 million. For the year ended December 31, 2010, we allocated $85.9 million of this charge ($76.5 million in the third quarter of 2010 and $9.4 million in the fourth quarter of 2010) to the retained technology escrow services business, based on a relative fair value basis, which charge continues to be included in our continuing results of operations as a component of intangible impairments in our consolidated statements of operations. As described in Note 7 of the Notes to Consolidated Financial Statements, our technology escrow services business, which had been reported in our former worldwide digital business reporting segment, is now reported as a component of our North American Physical Business segment.
In September 2011, as a result of certain changes we made in the manner in which our European operations will be managed, we reorganized our reporting structure and reassigned goodwill among the revised reporting units. As a result of the management and reporting changes, we concluded that we have three reporting units for our European operations: (1) the United Kingdom, Ireland and Norway ("UKI"), (2) Belgium, France, Germany, Italy, Luxembourg, Netherlands and Spain ("Western Europe") and (3) the remaining countries in Europe ("Central Europe"). Due to these changes, we will perform all future goodwill impairment analysis on the new reporting unit basis. As a result of the restructuring of our reporting units, we concluded that we had an interim triggering event, and, therefore, we performed an interim goodwill impairment test for UKI, Western Europe and Central
67
Europe in the third quarter of 2011. As required by GAAP, prior to our goodwill impairment analysis we performed an impairment test on the long-lived assets within our Western Europe reporting unit. The undiscounted cash flows from our Italian operations were lower than the carrying value of the long-lived assets associated with these operations and resulted in the requirement to fair value the long-lived assets of this lower level component. As a result, we recorded write-offs of other intangible assets, primarily customer relationship values, of $8.0 million during the quarter ending September 30, 2011, associated with our Italian operations which are a component of our Western Europe reporting unit. Additionally, we concluded that the goodwill of our UKI and Central Europe reporting units were not impaired. Our UKI and Central Europe reporting units have fair values that exceed their carrying values by 15.1% and 5.0%, respectively, as of August 31, 2011. Central Europe is still in the investment stage and accordingly its fair value does not exceed its carrying value by a significant margin at this point in time. A deterioration of the UKI or Central Europe businesses or the businesses not achieving the forecasted results could lead to impairments in future periods. Our Western Europe reporting unit's fair value was less than its carrying value, and, as a result, we recorded a provisional goodwill impairment charge included as a component of intangible impairments in our consolidated statements of operations for the quarter ending September 30, 2011 of $45.0 million. An estimated tax benefit of approximately $6.5 million was recorded associated with the Western Europe provisional goodwill impairment charge. The provisional charge is subject to refinement of forecast assumptions and results and valuation analyses necessary to calculate an implied fair value for goodwill. After the provisional impairment, the remaining Western Europe reporting unit goodwill is $52.6 million. We will finalize the provisional charge and record any necessary adjustments in the fourth quarter of 2011 (including to the estimated tax benefit).
OPERATING INCOME and ADJUSTED OIBDA
As a result of all the foregoing factors, (1) consolidated operating income increased $9.8 million, or 9.2%, to $116.8 million (15.1% of consolidated revenues) for the three months ended September 30, 2011 from $107.0 million (14.6% of consolidated revenues) for the three months ended September 30, 2010; (2) consolidated operating income decreased $7.0 million, or 1.7%, to $398.0 million (17.4% of consolidated revenues) for the nine months ended September 30, 2011 from $405.1 million (18.6% of consolidated revenues) for the nine months ended September 30, 2010; (3) consolidated Adjusted OIBDA increased $0.9 million, or 0.4%, to $252.3 million (32.7% of consolidated revenues) for the three months ended September 30, 2011 from $251.4 million (34.4% of consolidated revenues) for the three months ended September 30, 2010; and (4) consolidated Adjusted OIBDA decreased $4.5 million, or 0.6%, to $694.9 million (30.4% of consolidated revenues) for the nine months ended September 30, 2011 from $699.4 million (32.1% of consolidated revenues) for the nine months ended September 30, 2010.
OTHER EXPENSES, NET
Consolidated interest expense, net decreased $1.6 million to $50.4 million (6.5% of consolidated revenues) and $9.2 million to $148.4 million (6.5% of consolidated revenues) for the three and nine months ended September 30, 2011, respectively, from $52.1 million (7.1% of consolidated revenues) and $157.6 million (7.2% of consolidated revenues) for the three and nine months ended September 30, 2010, primarily due to the early retirement of $431.3 million of our 73/4% Senior Subordinated Notes due 2015 (the "73/4% notes due 2015") during late 2010 and early 2011. Our weighted average interest rate was 6.9% at both September 30, 2011 and 2010.
68
Other (Income) Expense, Net (in thousands)
Net foreign currency transaction losses of $14.4 million, based on period-end exchange rates, were recorded in the nine months ended September 30, 2011. Losses were primarily a result of British pound sterling denominated debt and forward foreign currency swap contracts, Euro denominated bonds issued by IMI and changes in the exchange rate of the Russian Ruble and certain Latin American currencies against the U.S. dollar compared to December 31, 2010, as these currencies relate to our intercompany balances with and between our European and Latin American subsidiaries. Partially offsetting these losses were gains which resulted primarily from changes in the exchange rate of the British pound sterling and Euro against the U.S. dollar compared to December 31, 2010, as these currencies relate to our intercompany balances with and between our European subsidiaries.
Net foreign currency transaction losses of $5.0 million, based on period-end exchange rates, were recorded in the nine months ended September 30, 2010. Losses resulted primarily from changes in the exchange rate of the British pound sterling, Euro, Russian ruble and certain Latin American currencies against the U.S. dollar compared to December 31, 2009, as these currencies relate to our intercompany balances with and between our European and Latin American subsidiaries, which were partially offset by gains as a result of British pound sterling denominated debt and forward foreign currency swap contracts and Euro denominated bonds issued by IMI.
We recorded a gain of approximately $0.9 million in the first quarter of 2011 related to the early extinguishment of $231.3 million of the 73/4% notes due 2015. This gain consists of original issue premiums, net of deferred financing costs related to the 73/4% notes due 2015 that were redeemed. Additionally, we recorded a charge of $1.8 million in the second quarter of 2011 related to the early retirement of our previous revolving credit and term loan facilities, representing a write-off of deferred financing costs. Other, net in the nine months ended September 30, 2011 also includes a $5.9 million gain associated with the fair valuing of the 20% equity interest that we previously held in our Polish joint venture in connection with our acquisition of the remaining 80% interest in January 2011.
A charge of $4.7 million is included in other (income) expense, net in the nine months ended September 30, 2010 related to the impact of the change in IME's fiscal year-end as of January 1, 2010. Since its inception, IME operated with an October 31 fiscal year-end. Therefore, IME's financial results had historically been consolidated with IMI's results with a two month lag. In order to better align our European processes with the enterprise, the IME fiscal year-end was changed to December 31 to match our fiscal year-end. The $4.7 million charge represents the net impact of this change for the two years ended December 31, 2009. During the three months ended September 30, 2010, we redeemed a portion of our 73/4% Notes due 2015 and wrote off $1.8 million in associated call premium and deferred financing costs, net of original issue premium.
Our effective tax rates for the three and nine months ended September 30, 2010 were 51.6% and 53.6%, respectively. Our effective tax rates for the three and nine months ended September 30, 2011 were 32.7% and 26.4%, respectively. The primary reconciling item between the federal statutory rate of
69
35% and our overall effective tax rate for the three and nine months ended September 30, 2010 is a goodwill impairment charge included in income from continuing operations as a component of intangible impairments in our consolidated statements of operations, of which a majority was non-deductible for tax purposes. The negative impact of U.S. legislative changes reducing the expected utilization of foreign tax credits was offset by the recognition of certain previously unrecognized tax benefits due to expirations of statute of limitation periods and settlements with tax authorities in various jurisdictions. Additionally, to a lesser extent, state income taxes (net of federal benefit) and differences in the rates of tax at which our foreign earnings are subject, including foreign exchange gains and losses in different jurisdictions with different tax rates, are also reconciling items and impact our effective tax rate. The primary reconciling item between the federal statutory rate of 35% and our overall effective tax rate for the three and nine months ended September 30, 2011 was a positive impact provided by the recognition of certain previously unrecognized tax benefits due to expirations of statute of limitation periods and settlements with tax authorities in various jurisdictions. During the three and nine months ended September 30, 2011, we recognized previously unrecognized tax benefits due to expirations of statute of limitation periods and settlements with tax authorities in various jurisdictions of $31.9 million and $36.2 million, respectively. This benefit was partially offset by a goodwill impairment charge included in income from continuing operations as a component of intangible impairments in our consolidated statements of operations, of which a majority was non-deductible for tax purposes. Additionally, to a lesser extent, state income taxes (net of federal benefit) and differences in the rates of tax at which our foreign earnings are subject, including foreign exchange gains and losses in different jurisdictions with different tax rates, are reconciling items that impact our effective tax rate.
INCOME FROM CONTINUING OPERATIONS
As a result of all the foregoing factors, (1) consolidated income from continuing operations for the three months ended September 30, 2011 increased $6.0 million, or 21.8%, to $33.5 million (4.3% of consolidated revenues) from income from continuing operations of $27.5 million (3.8% of consolidated revenues) for the three months ended September 30, 2010 and (2) consolidated income from continuing operations for the nine months ended September 30, 2011 increased $66.5 million, or 60.7%, to $176.2 million (7.7% of consolidated revenues) from income from continuing operations of $109.6 million (5.0% of consolidated revenues) for the nine months ended September 30, 2010.
INCOME (LOSS) FROM DISCONTINUED OPERATIONS AND GAIN (LOSS) ON SALE OF DISCONTINUED OPERATIONS
Loss from discontinued operations was $(178.3) million and $(192.9) million for the three and nine months ended September 30, 2010, respectively, and $(2.5) million and $(10.8) million for the three and nine months ended September 30, 2011, respectively. We recorded a provisional goodwill impairment charge associated with our former worldwide digital business reporting unit in the amount
70
of $178.5 million during the quarter ended September 30, 2010 net of the amount allocated to the retained technology escrow services business, based on a relative fair value basis, which continues to be included in our continuing results of operations as previously discussed above. During 2011, we recorded an impairment charge of $4.9 million to write-down the long-lived assets of the New Zealand Business to its estimated net realizable value which is included in income (loss) from discontinued operations. Additionally, we recorded a tax benefit of $7.6 million during 2011 associated with the outside tax basis of the New Zealand Business, which is also reflected in income (loss) from discontinued operations.
Pursuant to the Digital Sale Agreement, we received approximately $395.4 million in cash, consisting of the initial purchase price of $380.0 million and a preliminary working capital adjustment of approximately $15.4 million, which remains subject to a customary post-closing adjustment based on the amount of working capital at closing. The purchase price for the Digital Sale will be increased on a dollar-for-dollar basis if the working capital balance at the time of closing exceeds the target amount of working capital as set forth in the Digital Sale Agreement and decreased on a dollar-for-dollar basis if such closing working capital balance is less than the target amount. We and Autonomy are in disagreement regarding the working capital adjustment in the Digital Sale Agreement. As a result, as contemplated by the Digital Sale Agreement, the matter is being referred to an independent third party accounting firm for determination of the appropriate adjustment amount. Transaction costs amounted to approximately $7.4 million. Additionally, $11.1 million of inducements are payable to Autonomy and have been netted against the proceeds in calculating the gain on the Digital Sale. Also, an estimated tax benefit of $6.7 million and tax provision of $45.6 million associated with the gain recorded on the Digital Sale was recorded during the three and nine month periods ended September 30, 2011, respectively. A gain on sale of discontinued operations in the amount of $0.2 million ($6.9 million, net of tax benefit) and $245.8 million ($200.3 million, net of tax benefit) was recorded during the three and nine month periods ended September 30, 2011, respectively, as a result of the Digital Sale.
NONCONTROLLING INTERESTS
For the three and nine months ended September 30, 2011, net income attributable to noncontrolling interests resulted in a decrease in net income attributable to Iron Mountain Incorporated of $0.6 million and $2.1 million, respectively. Net income attributable to noncontrolling interests was $3.0 million and $3.7 million for the three and nine months ended September 30, 2010, respectively. These amounts represent our noncontrolling partners' share of earnings/losses in our majority-owned international subsidiaries that are consolidated in our operating results.
Segment Analysis (in thousands)
Beginning June 2011, as a result of the disposition of the Digital Business and our decision to sell the New Zealand Business as discussed in Note 10 to Notes to Consolidated Financial Statements, we changed our reportable segments. The most significant of these changes is that the reportable segment previously referred to as the Worldwide Digital Business is no longer reported separately in our management reporting because the operations associated with the Domain Name Product Line and the Digital Business are reported as discontinued operations. Also, the technology escrow services business, which we continue to own and operate and which was previously reported in the Worldwide Digital Business segment, is now reported as a component of the North American Physical Business segment. Additionally, the International Physical Business segment no longer includes the New Zealand Business because these operations are reported as discontinued operations.
Our reportable operating segments are North American Physical Business, International Physical Business and Corporate. See Note 7 to the Notes to Consolidated Financial Statements. Our North American Physical Business, offers information management services throughout the United States and Canada, including the storage of paper documents, as well as other media such as microfilm and
71
microfiche, master audio and videotapes, film, X-rays and blueprints, including healthcare information services, vital records services, service and courier operations, and the collection, handling and disposal of sensitive documents for corporate customers ("Hard Copy"); the storage and rotation of backup computer media as part of corporate disaster recovery plans, including service and courier operations ("Data Protection"); information destruction services ("Destruction"); the scanning, imaging and document conversion services of active and inactive records ("Hybrid Services"); the storage, assembly, and detailed reporting of customer marketing literature and delivery to sales offices, trade shows and prospective customers' sites based on current and prospective customer orders ("Fulfillment") and technology escrow services that protect and manage source code. Our International Physical Business segment offers information management services throughout Europe, Latin America and Asia Pacific, including Hard Copy, Data Protection, Destruction and Hybrid Services. Corporate consists of costs related to executive and staff functions, including finance, human resources and information technology, which benefit the enterprise as a whole. These costs are primarily related to the general management of these functions on a corporate level and the design and development of programs, policies and procedures that are then implemented in the individual segments, with each segment bearing its own cost of implementation. Corporate also includes stock-based employee compensation expense associated with all employee stock-based awards.
North American Physical Business
Segment Revenue
Segment Adjusted OIBDA(1)
Segment Adjusted OIBDA(1) as a
Percentage of Segment Revenue
During the nine months ended September 30, 2011, revenue in our North American Business segment increased 1.9% over the nine months ended September 30, 2010, primarily due to internal growth of 1.5%. Internal growth was due to storage internal growth of 2.1% related to increased new sales and lower volume outflows, as well as total service internal growth of 0.8%. Our core service revenues were constrained by lower service and activity levels partially offset by higher fuel surcharges, yielding negative internal growth of 1.1% for the first nine months of 2011, while our complementary service revenue yielded 6.0% internal growth as a result of higher pricing of recycled paper, as well as improved special project and product sales. Additionally, favorable foreign currency rate changes related to the Canadian dollar resulted in increased 2011 revenue, as measured in U.S. dollars, of 0.6%
72
for the first nine months of 2011. Adjusted OIBDA as a percentage of segment revenue decreased in the first nine months of 2011 compared to the first nine months of 2010 due mainly to planned increases in sales and marketing expenses of $8.0 million and higher incentive compensation accruals of $19.8 million, partially offset by a constant currency increase in revenue of $20.9 million.
International Physical Business
Revenue in our International Physical Business segment increased 13.6% during the first nine months of 2011 over the same period last year due to internal growth of 3.3% and foreign currency fluctuations in 2011, primarily in Europe, which resulted in increased 2011 revenue, as measured in U.S. dollars, of approximately 7.5% as compared to 2010. Total internal revenue growth for the segment for the nine months ended September 30, 2011 was supported by solid 5.8% storage internal growth and total service internal growth of 0.7%. Acquisitions contributed 2.8% of the increase in total reported international revenues in the nine months ended September 30, 2011, primarily due to our acquisitions in Poland in the first quarter of 2011 and Greece in the second quarter of 2010. Adjusted OIBDA as a percentage of segment revenue increased in the nine months ended September 30, 2011 compared to the comparable prior year period primarily due to increased operating income from productivity gains, pricing actions and disciplined cost management, offset by $6.6 million of additional productivity investments.
Corporate
Segment Adjusted OIBDA(1) as a Percentage of Consolidated Revenue
73
During the nine months ended September 30, 2011, expenses in the Corporate segment as a percentage of consolidated revenue increased 0.6% as compared to the nine months ended September 30, 2010 primarily due to $15.0 million of advisory fees and other costs associated with our recent proxy contest.
Liquidity and Capital Resources
The following is a summary of our cash balances and cash flows (in thousands) as of and for the nine months ended September 30,
Cash flows from operating activities—continuing operations
Cash flows from investing activities—continuing operations
Cash flows from financing activities—continuing operations
Cash and cash equivalents at the end of period
Net cash provided by operating activities from continuing operations was $450.2 million for the nine months ended September 30, 2011 compared to $430.7 million for the nine months ended September 30, 2010. The 4.5% increase resulted primarily from an increase in net income, excluding non-cash charges, of $33.9 million, partially offset by uses in working capital of $11.9 million and a decrease in realized foreign exchange gains of $2.5 million over the same period last year. Uses of working capital are primarily related to increases in amounts paid for income taxes and reductions in cash collections from customers associated with accounts receivable in 2011 compared to 2010.
Our business requires significant capital expenditures to support our expected revenue growth and ongoing operations as well as new products and services and increased profitability. These expenditures are included in the cash flows from investing activities. The nature of our capital expenditures has evolved over time along with the nature of our business. We make capital expenditures to support a number of different objectives. The majority of our capital goes to support business line growth and our ongoing operations, but we also expend capital to support the development and improvement of products and services and projects designed to increase our profitability. These expenditures are generally small and more discretionary in nature. Cash paid for our capital expenditures, cash paid for acquisitions (net of cash acquired) and additions to customer acquisition costs during the nine months ended September 30, 2011 amounted to $148.3 million, $75.2 million and $16.9 million, respectively. For the nine months ended September 30, 2011, capital expenditures, net, cash paid for acquisitions (net of cash acquired) and additions to customer acquisition costs were funded with cash flows provided by operating activities and cash equivalents on hand. Excluding potential future acquisitions, we expect our capital expenditures to be approximately $225.0 million in the year ending December 31, 2011. Included in our estimated capital expenditures for 2011 is approximately $18.0 million of real estate purchases.
74
Net cash used in financing activities from continuing operations was $320.2 million for the nine months ended September 30, 2011. During the nine months ended September 30, 2011, we received (i) $394.0 million in proceeds from the issuance of our 73/4% Senior Subordinated Notes due 2019; (ii) net borrowings under our revolving credit and term loan facilities and other debt of $117.1 million and; (iii) $81.9 million of proceeds from the exercise of stock options and purchases under the employee stock purchase plan. We used the proceeds from these financing transactions and cash on hand: (i) for the early retirement of $231.3 million of 73/4% notes due 2015; (ii) to repurchase $548.5 million of our common stock; (iii) to pay dividends in the amount of $125.7 million on our common stock; and (iv) to fund debt financing costs of $8.9 million.
In February 2010, our board of directors approved a share repurchase program authorizing up to $150.0 million in repurchases of our common stock, and in October 2010 our board of directors authorized up to an additional $200.0 million of such purchases. In May 2011, our board of directors authorized up to an additional $850.0 million of such purchases, for a total authorization of $1.2 billion. All purchases are subject to stock price, market conditions, corporate and legal requirements and other factors. Additionally, in May 2011, we entered into two prepaid variable share repurchase agreements to repurchase an aggregate of $250.0 million of our common stock. In the third quarter of 2011, both prepaid variable share repurchase agreements were settled and 7.5 million shares were delivered to us and retired. As of September 30, 2011 we had a remaining amount available for repurchase under our share repurchase program of $540.3 million, which represents approximately 9% in the aggregate of our outstanding common stock based on the closing price on such date. Between October 1, 2011 and November 3, 2011, we purchased an additional 4.2 million shares for approximately $129 million.
The following table is a summary of our repurchase activity under all of our share repurchase programs during the first nine months of 2011:
Authorizations remaining as of January 1,
Additional Authorizations
Repurchases paid
Repurchases unsettled
Authorization remaining as of September 30,
We are committed to stockholder payouts through a combination of share buybacks, ongoing quarterly dividends and potential one-time dividends of approximately $2.2 billion through 2013, with approximately $1.2 billion of capital returned to stockholders by May 2012. Through November 3, 2011, we have returned approximately $764 million to stockholders against these commitments. We expect to
75
fund future payouts with cash flows from operations and borrowings under existing and potentially additional debt instruments. With regard to our levels of indebtedness, we plan to operate around the mid-point of our target leverage ratio range of 3x—4x EBITDA (as defined in our revolving credit facility).
Financial instruments that potentially subject us to market risk consist principally of cash and cash equivalents (including money market funds and time deposits), restricted cash (primarily U.S. Treasuries) and accounts receivable. The only significant concentrations of liquid investments as of September 30, 2011 relate to cash and cash equivalents and restricted cash held on deposit with three global banks and four "Triple A" rated money market funds which we consider to be large, highly-rated investment-grade institutions. As per our risk management investment policy, we limit exposure to concentration of credit risk by limiting the amount invested in any one mutual fund or financial institution to a maximum of $50.0 million. As of September 30, 2011, our cash and cash equivalents and restricted cash balance was $516.0 million, including money market funds and time deposits amounting to $459.8 million. A substantial portion of these money market funds are invested in U.S. Treasuries.
We are highly leveraged and expect to continue to be highly leveraged for the foreseeable future. Our consolidated debt as of September 30, 2011 was comprised of the following (in thousands):
71/4% GBP Senior Subordinated Notes due 2014 (the "71/4% notes")(2)
65/8% Senior Subordinated Notes due 2016 (the "65/8% notes")(2)
71/2% CAD Senior Subordinated Notes due 2017 (the "Subsidiary notes")(3)
83/4% Senior Subordinated Notes due 2018 (the "83/4% notes")(2)
8% Senior Subordinated Notes due 2018 (the "8% notes")(2)
63/4% Euro Senior Subordinated Notes due 2018 (the "63/4% notes")(2)
73/4% Senior Subordinated Notes due 2019 (the "73/4% notes due 2019")(2)
8% Senior Subordinated Notes due 2020 (the "8% notes due 2020")(2)
83/8% Senior Subordinated Notes due 2021 (the "83/8% notes")(2)
Real Estate Mortgages, Capital Leases and Other
76
On June 27, 2011, we entered into a new credit agreement to replace the IMI revolving credit facility and the IMI term loan facility, each entered into on April 16, 2007. The new credit agreement consists of (i) revolving credit facilities under which we can borrow, subject to certain limitations as defined in the new credit agreement, up to an aggregate amount of $725.0 million (including Canadian dollar, British pound sterling and Euros, among other currencies) (the "New Revolving Credit Facility") and (ii) a $500.0 million term loan facility (the "New Term Loan Facility", and collectively with the New Revolving Credit Facility, the "New Credit Agreement"). We have the right to increase the aggregate amount available to be borrowed under the New Credit Agreement up to a maximum of $1.8 billion. The New Revolving Credit Facility is supported by a group of 19 banks. IMI, Iron Mountain Information Management, Inc. ("IMIM"), Canada Company, IME, Iron Mountain Australia Pty Ltd., Iron Mountain Switzerland Gmbh and any other subsidiary of IMIM designated by IMIM (the "Other Subsidiaries") may, with the consent of the administrative agent, as defined in the New Credit Agreement, borrow under certain of the following tranches of the New Revolving Credit Facility: (a) tranche one in the amount of $400.0 million is available to IMI and IMIM in U.S. dollars, British pound sterling and Euros, (b) tranche two in the amount of $150.0 million is available to IMI or IMIM in either U.S. dollars or Canadian dollars and available to Canada Company in Canadian dollars and (c) tranche three in the amount of $175.0 million is available to IMI or IMIM and the Other Subsidiaries in U.S. dollars, Canadian dollars, British pounds sterling, Euros and Australian dollars, among others. The New Revolving Credit Facility terminates on June 27, 2016, at which point all revolving credit loans under such facility become due. With respect to the New Term Loan Facility, loan payments are required through maturity on June 27, 2016 in equal quarterly installments of the aggregate annual amounts based upon the following percentage of the original principal amount in the table below (except that each of the first three quarterly installments in the fifth year shall be 10% of the original principal amount and the final quarterly installment in the fifth year shall be 35% of the original principal):
The New Term Loan Facility may be prepaid without penalty or premium, in whole or in part, at any time. IMI and IMIM guarantee the obligations of each of the subsidiary borrowers. The capital stock or other equity interests of most of the U.S. subsidiaries, and up to 66% of the capital stock or other equity interests of our first-tier foreign subsidiaries, are pledged to secure the New Credit Agreement, together with all intercompany obligations of foreign subsidiaries owed to us or to one of our U.S. subsidiary guarantors. The interest rate on borrowings under the New Credit Agreement varies depending on our choice of interest rate and currency options, plus an applicable margin, which varies based on certain financial ratios. Additionally, the New Credit Agreement requires the payment of a commitment fee on the unused portion of the revolving credit facility, which fee ranges from between 0.3% to 0.5% based on certain financial ratios, as well as fees associated with any outstanding letters of credit. Proceeds from the New Credit Agreement are for general corporate purposes and were used to repay the previous revolving credit and term loan facilities. We recorded a charge of $1.8 million to other expense (income), net in the second quarter of 2011 related to the early retirement of the previous revolving credit and term loan facilities, representing a write-off of deferred financings costs. As of September 30, 2011, we had $48.0 million of outstanding borrowings under the
77
New Revolving Credit Facility, all of which was denominated in Canadian dollars (CAD 50.0 million); we also had various outstanding letters of credit totaling $6.0 million. The remaining availability on September 30, 2011, based on IMI's leverage ratio, which is calculated based on the last 12 months' earnings before interest, taxes, depreciation and amortization ("EBITDA"), and other adjustments as defined in the New Credit Agreement and current external debt, under the New Revolving Credit Facility was $671.0 million. The interest rate in effect under the New Revolving Credit Facility and the New Term Loan Facility was 3.0% and 1.9%, respectively, as of September 30, 2011.
Our ability to pay interest on or to refinance our indebtedness depends on our future performance, working capital levels and capital structure, which are subject to general economic, financial, competitive, legislative, regulatory and other factors which may be beyond our control. There can be no assurance that we will generate sufficient cash flow from our operations or that future financings will be available on acceptable terms or in amounts sufficient to enable us to service or refinance our indebtedness or to make necessary capital expenditures.
In January 2011, we redeemed the remaining $231.3 million aggregate principal amount outstanding of our 73/4% Senior Subordinated Notes due 2015 at a redemption price of one thousand dollars for each one thousand dollars of principal amount of notes redeemed, plus accrued and unpaid interest. We recorded a gain to other expense (income), net of $0.9 million in the first quarter of 2011 related to the early extinguishment of the 73/4% notes being redeemed. This gain consists of original issue premiums, net of deferred financing costs related to the 73/4% notes that were redeemed.
In September 2011, we completed an underwritten public offering of $400.0 million in aggregate principal amount of our 73/4% Senior Subordinated Notes due 2019, which were issued at 100% of par. Our net proceeds of $394.0 million after paying the underwriters' discounts and commissions, will be used for general corporate purposes, including funding a portion of the shareholder payout commitments we have made and possible future acquisitions and investments.
On June 2, 2011, we completed the sale of the Digital Business to Autonomy. Pursuant to the Digital Sale Agreement, we received approximately $395.4 million in cash, consisting of the initial purchase price of $380.0 million and a preliminary working capital adjustment of approximately $15.4 million, which remains subject to a customary post-closing adjustment based on the amount of working capital at closing. The purchase price for the Digital Sale will be increased on a dollar-for-dollar basis if the working capital balance at the time of closing exceeds the target amount of working capital as set forth in the Digital Sale Agreement and decreased on a dollar-for-dollar basis if such closing working capital balance is less than the target amount. Transaction costs amounted to approximately $7.4 million. Additionally, $11.1 million of inducements are payable to Autonomy and have been netted against the proceeds in calculating the gain on the Digital Sale. We used the net
78
proceeds received from the Digital Sale to pay down amounts outstanding under our revolving credit facility and expect to use approximately $52.0 million of the net proceeds to fund cash taxes due as a result of the Digital Sale.
We expect to meet our cash flow requirements for the next twelve months from cash generated from operations, existing cash, cash equivalents, borrowings under the New Credit Agreement and other financings, which may include secured credit facilities, securitizations and mortgage or capital lease financings. We expect to meet our long-term cash flow requirements using the same means described above, as well as the potential issuance of debt or equity securities as we deem appropriate.
Net Operating Losses and Foreign Tax Credit Carryforwards
We have federal net operating loss carryforwards, which begin to expire in 2020 through 2029, of $28.2 million ($9.9 million, tax effected) at September 30, 2011 to reduce future federal taxable income. We have an asset for state net operating losses of $11.8 million (net of federal tax benefit), which begins to expire in 2011 through 2029, subject to a valuation allowance of approximately 99%. We have assets for foreign net operating losses of $33.0 million, with various expiration dates, subject to a valuation allowance of approximately 73%. We also have foreign tax credits of $57.9 million, which begin to expire in 2014 through 2019, subject to a valuation allowance of approximately 65%.
Inflation
Certain of our expenses, such as wages and benefits, insurance, occupancy costs and equipment repair and replacement, are subject to normal inflationary pressures. Although to date we have been able to offset inflationary cost increases through increased operating efficiencies and the negotiation of favorable long-term real estate leases, we can give no assurance that we will be able to offset any future inflationary cost increases through similar efficiencies, leases or increased storage or service charges.
Item 4. Controls and Procedures
The term "disclosure controls and procedures" is defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). These rules refer to the controls and other procedures of a company that are designed to ensure that information is recorded, processed, summarized and communicated to management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding what is required to be disclosed by a company in the reports that it files under the Exchange Act. As of September 30, 2011 (the "Evaluation Date"), we carried out an evaluation, under the supervision and with the participation of our management, including our chief executive officer and chief financial officer, of the effectiveness of our disclosure controls and procedures. Based upon that evaluation, our chief executive officer and chief financial officer have concluded that, as of the Evaluation Date, our disclosure controls and procedures are effective.
There have been no changes in our internal control over financial reporting during the quarter ended of September 30, 2011 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
79
Part II. Other Information
Item 1. Legal Proceedings
In September 2010, Iron Mountain do Brasil Ltda., our Brazilian operating subsidiary ("IMB"), was sued in Curitiba, Brazil in the 11th Lower Labor Claim Court. The plaintiff in the six related lawsuits, Sindicato dos Trabalhadores em Empresas de Serviços Contábeis, Assessoramento, Perícias, Informações, Pesquisas, e em Empresas Prestadoras de Serviços do Estado do Paraná (Union of Workers in Business Services Accounting, Advice, Expertise, Information, Research and Services Companies in the State of Parana), a labor union in Brazil, purported to represent 2,008 individuals who provided services for IMB. The complaint alleged that these individuals were incorrectly classified as non-employees by IMB and requested unspecified monetary damages, including attorneys' fees, unpaid wages, unpaid benefits and certain penalties. In August 2011, the court approved a settlement between the parties pursuant to which we will pay $2,000 for each of 531 individuals, subject to each individual's acceptance thereof. If all 531 individuals accept the settlement, it would result in payment by the Company of approximately $1.1 million. The claims of the remaining 1,477 individuals in the lawsuits not receiving proceeds in the settlement were dismissed by the court.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
There were no sales of unregistered securities for the three months ended September 30, 2011. The following table sets forth our common stock repurchased for the three months ended September 30, 2011:
Issuer Purchases of Equity Securities
July 1, 2011 - July 31, 2011
August 1, 2011 - August 31, 2011
September 1, 2011 - September 30, 2011
80
Item 6. Exhibits
(a) Exhibits
81
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
82