UNITED STATESSECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 2005
or
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period from to
Commission file number 1-13045
IRON MOUNTAIN INCORPORATED
(Exact Name of Registrant as Specified in its Charter)
Delaware
23-2588479
(State or Other Jurisdiction ofIncorporation or Organization)
(I.R.S. EmployerIdentification No.)
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 x No o
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes x No o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
Number of shares of the registrant’s Common Stock at November 1, 2005: 131,145,179
IRON MOUNTAIN INCORPORATEDIndex
Page
PART I—FINANCIAL INFORMATION
Item 1—Unaudited Consolidated Financial Statements
Consolidated Balance Sheets at December 31, 2004 and September 30, 2005(Unaudited)
3
Consolidated Statements of Operations for the Three Months Ended September 30, 2004 and 2005 (Unaudited)
4
Consolidated Statements of Operations for the Nine Months Ended September 30, 2004 and 2005 (Unaudited)
5
Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2004 and 2005 (Unaudited)
6
Notes to Consolidated Financial Statements (Unaudited)
7
Item 2—Management’s Discussion and Analysis of Financial Condition and Results ofOperations
29
Item 3—Quantitative and Qualitative Disclosures About Market Risk
45
Item 4—Controls and Procedures
46
PART II—OTHER INFORMATION
Item 1—Legal Proceedings
47
Item 2—Unregistered Sales of Equity Securities and Use of Proceeds
Item 6—Exhibits
Signature
48
2
Part I. Financial Information
Item 1. Unaudited Consolidated Financial Statements
IRON MOUNTAIN INCORPORATEDCONSOLIDATED BALANCE SHEETS(In Thousands, except Share and Per Share Data)(Unaudited)
December 31,2004
September 30,2005
ASSETS
Current Assets:
Cash and cash equivalents
$
31,942
43,990
Accounts receivable (less allowances of $13,886 and $12,862, respectively)
354,434
394,599
Deferred income taxes
36,033
32,789
Prepaid expenses and other
78,745
74,474
Total Current Assets
501,154
545,852
Property, Plant and Equipment:
Property, plant and equipment
2,266,839
2,436,077
Less—Accumulated depreciation
(617,043
)
(733,600
Net Property, Plant and Equipment
1,649,796
1,702,477
Other Assets, net:
Goodwill
2,040,217
2,050,575
Customer relationships and acquisition costs
189,780
196,722
Deferred financing costs
36,590
32,673
Other
24,850
24,191
Total Other Assets, net
2,291,437
2,304,161
Total Assets
4,442,387
4,552,490
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities:
Current portion of long-term debt
39,435
26,303
Accounts payable
103,415
111,683
Accrued expenses
234,697
246,736
Deferred revenue
136,470
142,234
Other current liabilities
1,446
885
Total Current Liabilities
515,463
527,841
Long-term Debt, net of current portion
2,438,587
2,382,139
Other Long-term Liabilities
23,932
29,210
Deferred Rent
26,253
30,722
Deferred Income Taxes
206,539
249,187
Commitments and Contingencies (see Note 9)
Minority Interests
13,045
5,969
Stockholders’ Equity:
Preferred stock (par value $0.01; authorized 10,000,000 shares; none issued and outstanding)
—
Common stock (par value $0.01; authorized 200,000,000 shares; issued and outstanding 129,817,914 shares and 131,130,089 shares, respectively)
1,298
1,311
Additional paid-in capital
1,063,560
1,090,256
Retained earnings
133,425
218,161
Accumulated other comprehensive items, net
20,285
17,694
Total Stockholders’ Equity
1,218,568
1,327,422
Total Liabilities and Stockholders’ Equity
The accompanying notes are an integral part of these consolidated financial statements.
IRON MOUNTAIN INCORPORATEDCONSOLIDATED STATEMENTS OF OPERATIONS(In Thousands, except Per Share Data)(Unaudited)
Three Months EndedSeptember 30,
2004
2005
Revenues:
Storage
263,867
296,784
Service and storage material sales
195,463
229,688
Total Revenues
459,330
526,472
Operating Expenses:
Cost of sales (excluding depreciation)
209,797
237,414
Selling, general and administrative
122,508
141,442
Depreciation and amortization
42,269
45,698
Gain on disposal/writedown of property, plant and equipment, net
(246
(259
Total Operating Expenses
374,328
424,295
Operating Income
85,002
102,177
Interest Expense, Net
54,313
44,308
Other Income, Net
(2,979
(6,542
Income Before Provision for Income Taxes and Minority Interest
33,668
64,411
Provision for Income Taxes
14,293
27,637
Minority Interest in Earnings of Subsidiaries
925
397
Net Income
18,450
36,377
Net Income per Share—Basic
0.14
0.28
Net Income per Share—Diluted
0.27
Weighted Average Common Shares Outstanding—Basic
129,288
130,862
Weighted Average Common Shares Outstanding—Diluted
131,366
132,283
Nine Months EndedSeptember 30,
768,232
873,805
570,430
665,995
1,338,662
1,539,800
608,934
696,130
353,456
418,095
119,912
134,989
(Gain) Loss on disposal/writedown of property, plant and equipment, net
(1,260
606
1,081,042
1,249,820
257,620
289,980
140,431
137,336
Other Expense, Net
4,236
3,067
112,953
149,577
46,668
63,739
1,981
1,102
64,304
84,736
0.50
0.65
0.49
0.64
128,934
130,439
131,056
131,757
IRON MOUNTAIN INCORPORATEDCONSOLIDATED STATEMENTS OF CASH FLOWS(In Thousands)(Unaudited)
Cash Flows from Operating Activities:
Net income
Adjustments to reconcile net income to cash flows from operating activities:
Minority interest in earnings of subsidiaries
Depreciation
112,334
122,970
Amortization (includes deferred financing costs and bond discount of $2,466 and $3,761, respectively)
10,044
15,780
Provision for deferred income taxes
41,448
49,303
Loss on early extinguishment of debt
2,454
Loss on foreign currency and other, net
8,607
4,392
Changes in Assets and Liabilities (exclusive of acquisitions):
Accounts receivable
(52,035
(42,054
Prepaid expenses and other current assets
5,043
(4,052
7,719
8,196
Accrued expenses, deferred revenue and other current liabilities
10,476
25,748
Other assets and long-term liabilities
(2,136
12,134
Cash Flows from Operating Activities
208,979
278,861
Cash Flows from Investing Activities:
Capital expenditures
(159,090
(189,711
Cash paid for acquisitions, net of cash acquired
(253,528
(46,096
Additions to customer relationship and acquisition costs
(9,512
(9,954
Proceeds from sales of property and equipment
2,508
9,574
Cash Flows from Investing Activities
(419,622
(236,187
Cash Flows from Financing Activities:
Repayment of debt and term loans
(891,151
(441,397
Proceeds from borrowings and term loans
862,042
396,624
Early retirement of notes
(20,797
Net proceeds from sales of senior subordinated notes
269,427
Debt financing (repayment to) and equity contribution from (distribution to) minority shareholders, net
(41,741
(2,021
Proceeds from exercise of stock options, debt and equity issuance costs and other, net
765
16,023
Cash Flows from Financing Activities
178,545
(30,771
Effect of exchange rates on cash and cash equivalents
1,843
145
(Decrease) Increase in Cash and Cash Equivalents
(30,255
12,048
Cash and Cash Equivalents, Beginning of Period
74,683
Cash and Cash Equivalents, End of Period
44,428
Supplemental Data:
Non-Cash Investing Activities:
Capital leases
1,506
8,106
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.
On May 27, 2005, Iron Mountain Incorporated, a Pennsylvania corporation (“Iron Mountain PA”), reincorporated as a Delaware corporation. The reincorporation was effected by means of a statutory merger (the “Merger”) of Iron Mountain PA with and into Iron Mountain Incorporated, a Delaware corporation (“Iron Mountain DE” or the “Company”), a wholly owned subsidiary of Iron Mountain PA. In connection with the Merger, Iron Mountain DE succeeded to and assumed all of the assets and liabilities of Iron Mountain PA. Apart from the change in its state of incorporation, the Merger had no effect on Iron Mountain PA’s business, board composition, management, employees, fiscal year, assets or liabilities, or location of its facilities, and did not result in any relocation of management or other employees. The Merger was approved at the Annual Meeting of Shareholders held on May 26, 2005. Upon consummation of the Merger, Iron Mountain DE succeeded to Iron Mountain PA’s reporting obligations and continued to be listed on the New York Stock Exchange under the symbol IRM.
The consolidated balance sheet presented as of December 31, 2004 has been derived from our audited consolidated financial statements. 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 are adequate to make the information presented not misleading. The consolidated financial statements and notes included herein should be read in conjunction with the consolidated financial statements and notes included in our Annual Report on Form 10-K for the year ended December 31, 2004.
(2) Summary of Significant Accounting Policies
a. Principles of Consolidation
The accompanying financial statements reflect our financial position and results of operations on a consolidated basis. Financial position and results of operations of Iron Mountain Europe Limited (“IME”), our European subsidiary, are consolidated for the appropriate periods based on its October 31 fiscal year end. All significant intercompany account balances have been eliminated or presented to reflect the underlying economics of the transactions.
b. Foreign Currency Translation
Local currencies are considered the functional currencies for most of our operations outside the United States. All assets and liabilities are translated at period-end exchange rates, and revenues and expenses are translated at average exchange rates for the applicable period, in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 52, “Foreign Currency Translation.” Resulting translation adjustments are reflected in the accumulated other comprehensive items component of stockholders’ equity. The gain or loss on foreign currency transactions, including those related to
IRON MOUNTAIN INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (In Thousands, Except Share and Per Share Data) (Unaudited)
(2) Summary of Significant Accounting Policies (Continued)
(a) U.S. dollar denominated 81¤8% senior notes of our Canadian subsidiary, which were fully redeemed as of March 31, 2004, (b) our 71¤4% GBP Senior Subordinated Notes due 2014, (c) the borrowings in certain foreign currencies under our revolving credit agreements, and (d) certain foreign currency denominated intercompany obligations of our foreign subsidiaries to us and between our foreign subsidiaries, are included in other (income) expense, net, on our consolidated statements of operations. Included in other (income) expense, net is $2,753 of net gains and $2,185 of net losses associated with foreign currency transactions for the three and nine months ended September 30, 2004, respectively, and $5,745 of net gains and $4,009 of net losses associated with foreign currency transactions for the three and nine months ended September 30, 2005, respectively.
c. Goodwill and Other Intangible Assets
We apply the provisions of SFAS No. 142, “Goodwill and Other Intangible Assets.” Under SFAS No. 142, goodwill and intangible assets with indefinite lives are not amortized but are reviewed annually for impairment or more frequently if impairment indicators arise. Separable intangible assets that are not deemed to have indefinite lives are amortized over their useful lives.
We have selected October 1 as our annual goodwill impairment review date. We performed our last annual goodwill impairment review as of October 1, 2004 and noted no impairment of goodwill at our reporting units as of that date. As of September 30, 2005, no factors were identified that would alter this assessment.
The changes in the carrying value of goodwill attributable to each reportable operating segment for the nine month period ended September 30, 2005 are as follows:
BusinessRecords
Data
Corporate
Total
Management
Protection
International
& Other
Consolidated
Balance as of December 31, 2004
1,290,651
246,966
424,373
78,227
Deductible Goodwill acquired during the period
12,981
1,124
14,105
Nondeductible Goodwill acquired during the period
3,433
5,315
3,033
11,781
Adjustments to purchase reserves
(119
(822
(230
(1,171
Fair value adjustments
(471
(132
(356
(1,107
(2,066
Currency effects and other adjustments
5,295
87
(17,673
(12,291
Balance as of September 30, 2005
1,311,770
253,360
408,555
76,890
8
The components of our amortizable intangible assets at September 30, 2005 are as follows:
Gross Carrying
Accumulated
Net Carrying
Amount
Amortization
Customer Relationships and Acquisition Costs
229,110
32,388
Core Technology(1)
15,460
2,259
13,201
Non-Compete Agreements(1)
1,418
915
503
Deferred Financing Costs
46,475
13,802
292,463
49,364
243,099
(1) Included in other assets, net in the accompanying consolidated balance sheet.
d. Stock-Based Compensation
As of January 1, 2003, we adopted the measurement provisions of SFAS No. 123, “Accounting for Stock-Based Compensation,” as amended by SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure.” As a result we began using the fair value method of accounting in our financial statements beginning January 1, 2003 using the prospective method. The prospective method involves recognizing expense for the fair value for all awards granted or modified in the year of adoption and thereafter with no expense recognition for previous awards. Additionally, we recognize expense related to the discount embedded in our employee stock purchase plan. We will apply the fair value recognition provisions to all stock based awards granted, modified or settled on or after January 1, 2003 and will continue to provide the required pro forma information for all awards previously granted, modified or settled before January 1, 2003.
Had we elected to recognize compensation cost for all awards based on the fair value of the options granted at grant date as prescribed by SFAS No. 123 and No. 148, net income and net income per share would have been changed to the pro forma amounts indicated in the table below:
Net income, as reported
Add: Stock-based employee compensation expense included in reported net income, net of tax benefit
1,578
1,646
2,501
3,338
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of tax benefit
(2,017
(1,862
(3,890
(4,195
Net income, pro forma
18,011
36,161
62,915
83,879
Net Income per share:
Basic—as reported
Basic—pro forma
Diluted—as reported
Diluted—pro forma
0.48
9
The weighted average fair value of options granted for the nine months ended September 30, 2004 and 2005 was $8.48 and $10.85 per share, respectively. The 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:
Weighted Average Assumption
Nine Months EndedSeptember 30, 2004
Nine Months EndedSeptember 30, 2005
Expected volatility
24.9
%
26.7
%(1)
Risk-free interest rate
3.41
4.04
Expected dividend yield
None
Expected life of the option
5.0 years
6.6 years
(1) Calculated utilizing daily historical volatility over a period that equates to the expected life of the option.
e. Income Per Share—Basic and Diluted
In accordance with SFAS No. 128, “Earnings per Share,” basic net income per common share is calculated by dividing net income by the weighted average number of common shares outstanding. The calculation of diluted net income per share is consistent with that of basic net income 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. Potential common shares, substantially attributable to stock options, included in the calculation of diluted net income per share totaled 2,078,369 shares and 1,421,135 shares for the three months ended September 30, 2004 and 2005, respectively, and 2,122,218 shares and 1,317,623 shares for the nine months ended September 30, 2004 and 2005, respectively. No potential common shares for the three and nine months ended September 30, 2004 and potential common shares of 274,641 and 531,520 for the three and nine months ended September 30, 2005, respectively, have been excluded from the calculation of diluted net income per share, as their effects are antidilutive.
f. Supplemental Cash Flow Information
For the nine months ended September 30, 2004 and 2005, cash payments for interest were $125,442 and $140,420, respectively, and cash payments for income taxes (net of refunds) were $7,820 and $7,712, respectively.
g. New Accounting Pronouncements
In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123R, “Share-Based Payment.” SFAS No. 123R is a revision of SFAS No. 123 and supersedes Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB No. 25”). We adopted the measurement provisions of SFAS No. 123 and SFAS No. 148 in our financial statements beginning January 1, 2003 using the prospective method. The prospective method involves recognizing expense for the fair value for all awards granted or modified in the year of adoption and thereafter with no
10
expense recognition for previous awards. We have applied the fair value recognition provisions to all stock based awards granted, modified or settled on or after January 1, 2003.
Among other items, SFAS No. 123R eliminates the use of APB No. 25 and the intrinsic value method of accounting, and requires companies to recognize the cost of employee services received in exchange for awards of equity instruments, based on the grant date fair value of those awards, in the financial statements. The effective date of SFAS No. 123R is the first fiscal year beginning after June 15, 2005, which would be our first quarter of 2006, although early adoption is allowed. SFAS No. 123R permits companies to adopt its requirements using either a “modified prospective” method, or a “modified retrospective” method. Under the “modified prospective” method, compensation cost is recognized in the financial statements beginning with the effective date, based on the requirements of SFAS No. 123R for all share-based payments granted after that date, and based on the requirements of SFAS No. 123 for all unvested awards granted prior to the effective date of SFAS No. 123R. Under the “modified retrospective” method, the requirements are the same as under the “modified prospective” method, but this method also permits entities to restate financial statements of previous periods based on proforma disclosures made in accordance with SFAS No. 123.
SFAS No. 123R also requires that the benefits associated with the tax deductions in excess of recognized compensation cost be reported as a financing cash flow, rather than as an operating cash flow as required under current rules. This requirement will reduce net operating cash flows and increase net financing cash flows in periods after the effective date. Since we do not pay significant cash taxes currently, we do not expect this provision to materially impact our statement of cash flows within the next few years.
We expect to adopt SFAS No. 123R effective January 1, 2006 using the modified prospective method of implementation. Subject to a complete review of the requirements of SFAS No. 123R, based on outstanding stock options granted to employees prior to our prospective implementation of the measurement provisions of SFAS No. 123 and SFAS No. 148 on January 1, 2003, we expect to record approximately $900 of stock compensation expense in 2006 associated with unvested stock option grants issued prior to January 1, 2003.
In March 2005, the FASB issued FASB Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations, an interpretation of FASB Statement No. 143” (FIN 47). FIN 47 clarifies that conditional asset retirement obligations meet the definition of liabilities and should be recognized when incurred if their fair values can be reasonably estimated. FIN 47 is effective no later than December 31, 2005. The cumulative effect of initially applying FIN 47 will be recognized as a change in accounting principle. We are in the process of evaluating the effect of FIN 47 on our consolidated results of operations and financial position.
11
(3) Comprehensive Income
SFAS No. 130, “Reporting Comprehensive Income,” requires presentation of the components of comprehensive income, including the changes in equity from non-owner sources such as unrealized gains (losses) on hedging transactions, securities and foreign currency translation adjustments. Our total comprehensive income is as follows:
Comprehensive Income:
Other Comprehensive Income (Loss):
Foreign Currency Translation Adjustments
5,602
(8,531
2,437
(4,778
Market Value Adjustments for Hedging Contracts, Net of Tax
6,625
196
12,993
2,035
Market Value Adjustments for Securities, Net of Tax
(206
163
(190
152
Comprehensive Income
30,471
28,205
79,544
82,145
(4) Derivative Instruments and Hedging Activities
SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” requires that every derivative instrument 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 that are subject to 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 hedge 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 a range of 80% to 85% of our debt portfolio to be fixed with respect to interest rates. Occasionally, we will use floating to fixed interest rate swaps as a tool to maintain our targeted level of fixed rate debt. In addition we will use borrowings in foreign currencies, either obtained in the U.S. or by our foreign subsidiaries, to economically hedge foreign currency risk associated with our international investments.
We have entered into two interest rate swap agreements, which are derivatives as defined by SFAS No. 133 and designated as cash flow hedges. These swap agreements hedge interest rate risk on certain amounts of our term loan. We have recorded, in the accompanying consolidated balance sheet, the estimated cost to terminate these swaps (fair value of the derivative liability), a deferred tax asset and a corresponding charge to accumulated other comprehensive items of $534, $195 and $339, respectively, as of September 30, 2005. For the three and nine months ended September 30, 2004, we recorded additional interest expense of $2,149 and $6,642, respectively, resulting from interest rate swap cash payments. For the three and nine months ended September 30, 2005, we recorded additional interest expense of $781 and
12
(4) Derivative Instruments and Hedging Activities (Continued)
$3,549, respectively, resulting from interest rate swap cash payments. These interest rate swap agreements were determined to be highly effective, and therefore no ineffectiveness was recorded in earnings.
In addition, we have entered into a third interest rate swap agreement, which was designated as a cash flow hedge through December 31, 2002. This swap agreement hedged interest rate risk on certain amounts of our variable operating lease commitments. This swap expired in March 2005. The total impact of marking to market the fair market value of the derivative liability and cash payments associated with the interest rate swaps agreement resulted in our recording interest expense of $23 and $1,249 for the three and nine months ended September 30, 2004, respectively. The total impact of marking to market the fair market value of the derivative liability and cash payments associated with the interest rate swaps agreement resulted in our recording interest income of $6 for the nine months ended September 30, 2005.
Also, we consolidated a variable interest entity (“VIE III”, collectively with our two other variable interest entities, our “Variable Interest Entities”) which had entered into an interest rate swap agreement upon its inception that was designated as a cash flow hedge. This swap agreement hedged the majority of interest rate risk associated with VIE III’s then existing real estate term loans. We have recorded, in the accompanying consolidated balance sheet, the estimated cost to terminate this swap of $3,298 ($2,634 recorded in accrued expenses and $664 recorded in other long-term liabilities) as of September 30, 2005. As a result of the repayment of the real estate term loans in the third quarter of 2004, we began marking to market the fair value of the derivative liability. The total impact of marking to market the fair market value of the derivative liability and cash payments associated with the interest rate swap agreement resulted in our recording interest expense of $9,598 and $12,057 for the three and nine months ended September 30, 2004, respectively, and interest income of $974 and $1,367 for the three and nine months ended September 30, 2005, respectively.
In July 2003, we provided the initial financing totaling 190,459 British pounds sterling to IME for all of the consideration associated with the acquisition of the European information management services business of Hays plc (“Hays IMS”) using cash on hand and borrowings under our revolving credit facility. In March 2004, IME repaid 135,000 British pounds sterling with proceeds from their new credit agreement (see Note 6). We recorded a foreign currency gain of $11,866 in other expense, net for this intercompany activity in the first quarter of 2004. In order to minimize the foreign currency risk associated with providing IME with the consideration necessary for the acquisition of Hay IMS, we borrowed 80,000 British pounds sterling under our revolving credit facility to create an economic hedge. In the first quarter of 2004, these borrowings were repaid and we recorded a foreign currency loss of $2,995 on the translation to U.S. dollars in other (income) expense, net.
In addition, on July 16, 2003, we entered into two cross currency swaps with a combined notional value of 100,000 British pounds sterling. We settled these swaps in March 2004 by paying our counter parties a total of $27,714 representing the fair market value of the derivative and the associated swap costs, of which $18,978 was accrued for as of December 31, 2003. In the first quarter of 2004, we recorded a foreign currency loss for this swap of $8,736 in other expense, net in the accompanying consolidated statement of operations. Upon cash payment, we received $162,800 in exchange for 100,000 British pounds sterling. We
13
did not designate these swaps as hedges and, therefore, all mark to market fluctuations of the swaps were recorded in other (income) expense, net in our consolidated statements of operations from inception to cash payment of the swaps.
In April 2004, IME entered into two floating for fixed interest rate swap contracts, each with a notional value of 50,000 British pounds sterling and a duration of two years, which were designated as cash flow hedges. These swap agreements hedge interest rate risk on IME’s 100,000 British pounds sterling term loan facility (see Note 6). We have recorded, in the accompanying consolidated balance sheet, the fair value of the derivative liability, a deferred tax asset and a corresponding charge to accumulated other comprehensive items of $429 (which was all recorded in accrued expenses), $129 and $300, respectively, as of September 30, 2005. For the three and nine months ended September 30, 2004, we recorded additional interest expense of $16 and $218, respectively, resulting from interest rate swap cash payments. For the three and nine months ended September 30, 2005, we recorded additional interest income of $9 and $52, respectively, resulting from interest rate swap cash payments. These interest rate swap agreements were determined to be highly effective, and therefore no ineffectiveness was recorded in earnings.
(5) Acquisitions
We account for acquisitions using the purchase method of accounting, and accordingly, the results of operations for each acquisition has been included in our consolidated results from their respective acquisition dates. Cash consideration for the various 2005 acquisitions was provided through cash flows from operations.
A summary of the consideration paid and the allocation of the purchase price of all 2005 acquisitions is as follows:
Cash Paid (net of cash acquired)
45,660
Fair Value of Identifiable Net Assets Acquired:
Fair Value of Identifiable Assets Acquired(1)
(13,265
Liabilities Assumed(2)
2,309
Minority Interest(3)
(8,818
Total Fair Value of Identifiable Net Assets Acquired
(19,774
Recorded Goodwill
25,886
(1) Comprised primarily of accounts receivable, prepaid expenses and other, land, buildings, racking, leasehold improvements, and customer relationship assets.
(2) Comprised primarily of accounts payable, accrued expenses and notes payable.
(3) Comprised primarily of the carrying value of minority interests of Latin American partners at the date of acquisition.
14
(5) Acquisitions (Continued)
Allocation of the purchase price for the 2005 acquisitions was based on estimates of the fair value of net assets acquired, and is subject to adjustment. The purchase price allocations of certain 2004 and 2005 transactions are subject to finalization of the assessment of the fair value of property, plant and equipment, intangible assets (primarily customer relationship assets), operating leases, restructuring purchase reserves and deferred income taxes. We are not aware of any information that would indicate that the final purchase price allocations will differ meaningfully from preliminary estimates.
In connection with certain of our acquisitions, we have undertaken certain restructurings of the acquired businesses. The restructuring activities include certain reductions in staffing levels, elimination of duplicate facilities and other costs associated with exiting certain activities of the acquired businesses. The estimated cost of these restructuring activities were recorded as costs of the acquisitions and were provided for in accordance with Emerging Issues Task Force Issue No. 95-3, “Recognition of Liabilities in Connection with a Purchase Business Combination.” We finalize restructuring plans for each business no later than one year from the date of acquisition. Unresolved matters at September 30, 2005 primarily include completion of planned abandonments of facilities and severance contracts in connection with certain acquisitions.
The following is a summary of reserves related to such restructuring activities:
Year EndedDecember 31, 2004
Reserves, Beginning Balance
16,322
21,414
Reserves Established
15,282
575
Expenditures
(10,200
(5,306
Adjustments to Goodwill, including currency effect(1)
(2,217
Reserves, Ending Balance
14,466
(1) Includes adjustments to goodwill as a result of management finalizing its restructuring plans.
At September 30, 2005, the restructuring reserves related to acquisitions consisted of lease losses on abandoned facilities of $10,662, severance costs for approximately 23 people of $284 and other exit costs of $3,520. These accruals are expected to be used prior to September 30, 2006 except for lease losses of $7,561 and severance contracts of $104, both of which are based on contracts that extend beyond one year.
15
(6) Long-term Debt
Long-term debt consists of the following:
December 31, 2004
September 30, 2005
CarryingAmount
FairValue
IMI Revolving Credit Facility(1)
122,563
102,455
IMI Term Loan Facility(1)
349,000
346,375
IME Revolving Credit Facility(1)
101,478
84,709
IME Term Loan Facility(1)
184,330
175,830
81¤4% Senior Subordinated Notes due 2011(2)
149,715
154,500
149,749
152,250
85¤8% Senior Subordinated Notes due 2013(2)
481,054
509,726
481,038
500,109
71¤4% GBP Senior Subordinated Notes due 2014(2)
288,990
275,263
264,420
255,165
73¤4% Senior Subordinated Notes due 2015(2)
440,418
435,568
439,734
436,646
65¤8% Senior Subordinated Notes due 2016(2)
314,565
299,200
314,935
Real Estate Mortgages(1)
5,908
7,015
Seller Notes(1)
11,307
9,627
Other(1)
28,694
32,555
Total Long-term Debt
2,478,022
2,408,442
Less Current Portion
(39,435
(26,303
Long-term Debt, Net of Current Portion
(1) The fair value of this long-term debt either approximates the carrying value (as borrowings under these debt instruments are based on current variable market interest rates as of December 31, 2004 and September 30, 2005) or it is impracticable to estimate the fair value due to the nature of such long-term debt.
(2) The fair values of these Senior Subordinated notes are based on quoted market prices for these notes on December 31, 2004 and September 30, 2005.
In March 2004, IME and certain of its subsidiaries entered into a credit agreement (the “IME Credit Agreement”) with a syndicate of European lenders. The IME Credit Agreement provides for maximum borrowing availability in the principal amount of 200,000 British pounds sterling, including a 100,000 British pounds sterling revolving credit facility (the “IME revolving credit facility”), which includes the ability to borrow in certain other foreign currencies and a 100,000 British pounds sterling term loan (the “IME term loan facility”). The IME revolving credit facility matures on March 5, 2009. The IME term loan facility is payable in three installments; two installments of 20,000 British pounds sterling on March 5, 2007 and 2008, respectively, and the final payment of the remaining balance on March 5, 2009. Our consolidated balance sheet as of September 30, 2005 includes 100,000 British pounds sterling and 69,809 Euro of borrowings (totaling $260,539) under the IME Credit Agreement. The remaining availability, based on its current level of external debt and the leverage ratio under the IME revolving credit facility on July 31, 2005, was approximately 38,401 British pounds sterling ($67,693). The interest rate in effect under the IME revolving credit facility ranged from 3.6% to 6.2% as of July 31, 2005. For the three and nine
16
(6) Long-term Debt (Continued)
months ended September 30, 2005, we recorded commitment fees of $210 and $629, respectively, based on 0.9% of unused balances under the IME revolving credit facility.
On April 2, 2004 and subsequently on July 8, 2004, we entered into a new amended and restated revolving credit facility and term loan facility (the “IMI Credit Agreement”) to replace our prior credit agreement and to reflect more favorable pricing of our term loans. The IMI Credit Agreement has an aggregate principal amount of $550,000 and is comprised of a $350,000 revolving credit facility (the “IMI revolving credit facility”), which includes the ability to borrow in certain foreign currencies, and a $200,000 term loan facility (the “IMI term loan facility”). The IMI revolving credit facility matures on April 2, 2009. With respect to the IMI term loan facility, quarterly loan payments of $500 began in the third quarter of 2004 and will continue through maturity on April 2, 2011, at which time the remaining outstanding principal balance of the IMI term loan facility is due. In November 2004, we entered into an additional $150,000 of term loans as permitted under our IMI Credit Agreement. The new term loans will mature at the same time as our current IMI term loan facility with quarterly loan payments of $375 that began in the first quarter of 2005 and will be priced at LIBOR plus a margin of 1.75%. The interest rate on borrowings under the IMI Credit Agreement varies depending on our choice of interest rate and currency options, plus an applicable margin. All intercompany notes and the capital stock of most of our U.S. subsidiaries are pledged to secure the IMI Credit Agreement. As of September 30, 2005, we had $102,455 of borrowings under our IMI revolving credit facility, all of which were denominated in Canadian dollars (CAD 119,943); we also had various outstanding letters of credit totaling $23,971. The remaining availability, based on IMI’s current level of external debt and the leverage ratio under the IMI revolving credit facility, on September 30, 2005 was $223,574. The interest rate in effect under the IMI revolving credit facility was 4.6% as of September 30, 2005. For the three and nine months ended September 30, 2005, we recorded commitment fees of $217 and $660, respectively, based on 0.5% of unused balances under the IMI revolving credit facility.
The IME Credit Agreement, IMI 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 IME Credit Agreement and IMI Credit Agreement and the indentures and other agreements governing our indebtedness. We were in compliance with all material debt covenants as of September 30, 2005.
17
(7) Selected Financial Information of Parent, Guarantors and Non-Guarantors
The following financial data summarizes the consolidating Company on the equity method of accounting as of December 31, 2004 and September 30, 2005 and for the three and nine month periods ended September 30, 2004 and 2005. The Guarantors column includes all subsidiaries that guarantee the senior subordinated notes, the IMI revolving credit facility and the IMI term loan facility. The subsidiaries that do not guarantee the senior subordinated notes are referred to in the table as the “Non-Guarantors.”
Parent
Guarantors
Non-Guarantors
Eliminations
Assets
Cash and Cash Equivalents
11,021
20,921
Accounts Receivable
239,015
115,419
Intercompany Receivable
869,370
(869,370
Other Current Assets
1,064
83,977
30,146
(409
114,778
870,434
334,013
166,486
(869,779
Property, Plant and Equipment, Net
1,131,277
518,519
Other Assets, Net:
Long-term Notes Receivable from Affiliates and Intercompany Receivable
1,923,614
11,420
(1,935,034
Investment in Subsidiaries
479,270
182,866
1,061
(663,197
1,435,151
594,264
10,802
30,128
116,438
105,196
(542
251,220
Total Other Assets, Net
2,433,012
1,745,875
700,521
(2,587,971
3,303,446
3,211,165
1,385,526
(3,457,750
Liabilities and Stockholders’ Equity
Intercompany Payable
313,259
556,111
Current Portion of Long-term Debt
3,823
2,355
33,257
Total Other Current Liabilities
51,190
298,755
126,492
476,028
2,024,224
112
414,251
Long-term Notes Payable to Affiliates and Intercompany Payable
1,000
10,420
4,641
212,083
40,542
256,724
Commitments and Contingencies
4,177
8,868
Stockholders’ Equity
460,987
200,276
(661,263
18
(7) Selected Financial Information of Parent, Guarantors and Non-Guarantors (Continued)
18,419
25,571
279,694
114,905
868,642
(868,642
195
68,696
38,807
(435
107,263
868,837
366,809
179,283
(869,077
1,169,047
533,430
1,975,741
11,121
(1,986,862
503,898
213,256
(717,154
1,457,015
583,819
9,741
27,532
120,044
106,488
(478
253,586
2,507,171
1,801,436
690,307
(2,694,753
3,376,008
3,337,292
1,403,020
(3,563,830
276,952
591,690
3,838
4,451
18,014
46,632
332,794
122,547
501,538
1,993,263
4,289
384,587
10,121
3,853
256,189
49,555
309,119
1,602
4,367
486,876
224,904
(711,780
19
Three Months Ended September 30, 2004
195,460
68,407
Service and Storage Material Sales
136,647
58,816
332,107
127,223
Cost of Sales (Excluding Depreciation)
146,680
63,117
Selling, General andAdministrative
(42
90,979
31,571
Depreciation and Amortization
31,605
10,655
(Gain) Loss on Disposal/Writedown of Property, Plant and Equipment, Net
(286
40
Total Operating (Income) Expenses
(33
268,978
105,383
33
63,129
21,840
37,477
616
16,220
Equity in the (Earnings) Losses of Subsidiaries
(54,553
1,207
53,346
Other (Income) Expense, Net
(1,341
(4,502
2,864
65,808
2,756
(53,346
11,379
2,914
Net Income (Loss)
54,429
(1,083
20
Three Months Ended September 30, 2005
217,723
79,061
169,050
60,638
386,773
139,699
Cost of Sales (ExcludingDepreciation)
170,882
66,532
27
108,498
32,917
32,780
12,905
Gain on Disposal/Writedown of Property, Plant and Equipment,Net
(163
(96
311,997
112,258
Operating (Loss) Income
(40
74,776
27,441
Interest Expense (Income), Net
38,876
(8,316
13,748
Equity in the Earnings of Subsidiaries
(68,834
(10,805
79,639
(6,459
2,691
(2,774
91,206
16,467
(79,639
22,181
5,456
69,025
10,614
21
Nine Months Ended September 30, 2004
572,912
195,320
Service and Storage MaterialSales
408,225
162,205
981,137
357,525
432,936
175,998
Selling, General and Administrative
81
264,541
88,834
25
91,286
28,601
(1,365
105
106
787,398
293,538
(106
193,739
63,987
112,018
(9,797
38,210
(179,545
(6,067
185,612
Other Expense (Income), Net
3,117
(8,295
9,414
217,898
16,363
(185,612
38,674
7,994
179,224
6,388
22
Nine Months Ended September 30, 2005
638,225
235,580
479,207
186,788
1,117,432
422,368
492,383
203,747
109
316,334
101,652
44
97,180
37,765
Loss (Gain) on Disposal/Writedown of Property, Plant and Equipment, Net
709
(103
153
906,606
343,061
(153
210,826
79,307
117,053
(24,861
45,144
(176,717
(20,750
197,467
Other (income) Expense, Net
(25,225
28,232
60
228,205
34,103
(197,467
52,132
11,607
176,073
21,394
23
(140,178
303,838
45,319
(108,193
(50,897
(52,053
(201,475
Intercompany loans to subsidiaries
160,067
188,709
(348,776
Investment in subsidiaries
(111,988
223,976
(7,593
(1,919
54
48,079
(88,664
(254,237
(124,800
(591,649
(205,162
(94,340
408,192
453,850
Early retirement of senior subordinated notes
Intercompany loans from parent
(163,557
(185,219
348,776
Equity contribution from parent
111,988
(223,976
Other, net
6,129
(5,364
92,099
(256,731
218,377
124,800
(Decrease) Increase in cash and cash equivalents
(41,557
11,302
Cash and cash equivalents, beginning of period
54,793
19,890
Cash and cash equivalents, end of period
13,236
31,192
24
(114,655
328,138
65,378
(129,259
(60,452
(26,786
(19,310
119,950
(47,122
(72,828
(15,686
31,372
(5,535
(4,419
9,558
104,264
(214,830
(84,165
(41,456
(264,145
(771
(176,481
258,318
138,306
(120,825
47,997
72,828
15,686
(31,372
16,218
(195
10,391
(105,910
23,292
41,456
Increase in cash and cash equivalents
7,398
4,650
Cash and cash equivalents, beginning ofperiod
(8) Segment Information
An analysis of our business segment information and reconciliation to the consolidated financial statements is as follows:
BusinessRecordsManagement
DataProtection
Corporate& Other
TotalConsolidated
Three Months Ended September 30,2004
Revenue
279,326
70,250
98,689
11,065
Contribution
71,096
20,065
23,925
11,939
127,025
Expenditures for Segment Assets(2)
95,407
4,521
19,636
12,750
132,314
Three Months Ended September 30,2005
303,438
83,944
105,130
33,960
85,592
25,818
28,146
8,060
147,616
37,965
10,956
15,851
7,570
72,342
Nine Months Ended September 30,2004
823,305
204,775
279,503
31,079
221,905
58,853
68,421
27,093
376,272
2,671,816
387,932
967,052
179,428
(1)
4,206,228
170,796
15,508
207,756
28,070
422,130
Nine Months Ended September 30,2005
900,102
237,671
321,410
80,617
256,567
70,472
81,422
17,114
425,575
2,797,095
423,761
1,017,864
313,770
120,882
21,862
70,050
32,967
245,761
(1) Total corporate & other assets include the intersegment elimination amounts of $1,870,821 and $1,809,271 as of September 30, 2004 and 2005, respectively.
(2) Includes capital expenditures, cash paid for acquisitions, net of cash acquired and additions to customer relationship and acquisition costs in the accompanying consolidated statements of cash flows.
The accounting policies of the reportable segments are the same as those described in Note 2 to Notes to Consolidated Financial Statements in our Annual Report on Form 10-K for the year ended December 31, 2004 except that certain costs continue to be allocated by Corporate to the other segments in both 2004 and 2005, primarily to our Business Records Management and Data Protection segments. These allocations, which include rent, worker’s compensation, property, general liability, auto and other insurance, pension/medical costs, incentive compensation, real estate property taxes and provision for bad debts, are based on rates set at the beginning of each year. Contribution for each segment is defined as
26
(8) Segment Information (Continued)
total revenues less cost of sales (excluding depreciation) and selling, general and administrative expenses (including the costs allocated to each segment as described above). Internally, we use Contribution as the basis for evaluating the performance of and allocating resources to our operating segments.
A reconciliation of Contribution to net income on a consolidated basis is as follows:
Less: Depreciation and Amortization
Information about our operations in different geographical areas is as follows:
United States
333,110
385,886
983,785
1,116,730
United Kingdom
69,549
67,230
203,754
206,992
Canada
27,533
33,353
75,374
97,319
Other International
29,138
40,003
75,749
118,759
Long-lived Assets:
2,735,545
2,796,046
618,712
589,274
315,872
331,899
271,104
289,419
Total Long-lived Assets
3,941,233
4,006,638
(9) Commitments and Contingencies
We are a party to numerous operating leases. No material changes in the obligations associated with these leases have occurred since December 31, 2004. See our Annual Report on Form 10-K for the year ended December 31, 2004 for amounts outstanding at December 31, 2004.
We and Iron Mountain Information Management, Inc. (“IMIM”), our wholly owned subsidiary, entered into two interrelated agreements with all necessary parties for the settlement and general release of all claims asserted in the Pierce, H-W Associates, Pioneer and Sequedex proceedings in New Jersey and Pennsylvania described in our Annual Report on Form 10-K for the year ended December 31, 2004. The settlement agreements, which were consummated on June 2, 2005, fully resolve and settle all the related litigations. Under the settlement agreements, we paid an aggregate of $3,100 to fully settle all claims in these actions, which includes approximately $2,100 previously awarded by the arbitrator to indemnify Mr. Pierce for legal expenses incurred in the proceeding. The $3,100 was fully reserved as of December 31, 2004 and included in accrued expenses in the accompanying consolidated balance sheet.
Other than the matters discussed above, there have been no material developments during the nine months ended September 30, 2005 in the proceedings described in our Annual Report on Form 10-K for the year ended December 31, 2004 or our Quarterly Reports on Form 10-Q for the quarters ended March 31, 2005 and June 30, 2005.
Additionally, we are involved in litigation from time to time in the ordinary course of business with a portion of the defense and/or settlement costs being covered by various commercial liability insurance policies purchased by us. In the opinion of management, no material legal proceedings, other than those described above and in our Annual Report on Form 10-K for the year ended December 31, 2004 and our Quarterly Reports on Form 10-Q for the quarters ended March 31, 2005 and June 30, 2005, are pending to which we, or any of our properties, are subject. In addition, we record legal costs associated with loss contingencies as expenses in the period in which they are incurred.
(10) Subsequent Events
In October 2005, the Company signed a definitive agreement to acquire the Australian and New Zealand operations of Pickfords Records Management for total cash consideration of approximately Australian Dollar 115,000 (US$87,000). The transaction is subject to customary closing conditions and regulatory approvals and is expected to be completed by year end.
We sold a facility in the U.K. for total cash proceeds of approximately $9,000 and will record a gain on the sale of approximately $4,500 in the fourth quarter of 2005.
28
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, 2005 should be read in conjunction with our consolidated financial statements and notes thereto for the three and nine months ended September 30, 2005 included herein, and the year ended December 31, 2004, included in our Annual Report on Form 10-K for the year ended December 31, 2004.
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, strategies, objectives, plans and current expectations. 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) changes in customer preferences and demand for our services; (2) changes in the price for our services relative to the cost of providing such services; (3) in the various digital businesses in which we are engaged, capital and technical requirements will be beyond our means, markets for our services will be less robust than anticipated, or competition will be more intense than anticipated; (4) our ability or inability to complete acquisitions on satisfactory terms and to integrate acquired companies efficiently; (5) the cost and availability of financing for contemplated growth; (6) business partners upon whom we depend for technical assistance or management and acquisition expertise outside the U.S. will not perform as anticipated; (7) changes in the political and economic environments in the countries in which our international subsidiaries operate; and (8) 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. You should read these cautionary statements as being applicable to all forward-looking statements wherever they appear. 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 SEC.
Non-GAAP Measures
Operating Income Before Depreciation and Amortization, or OIBDA
OIBDA is defined as operating income before depreciation and amortization expenses. OIBDA Margin is calculated by dividing OIBDA by total revenues. Our management uses these measures to evaluate the operating performance of our consolidated business. As such, we believe these measures provide relevant and useful information to our current and potential investors. We use OIBDA for planning purposes and multiples of current or projected OIBDA-based calculations in conjunction with our discounted cash flow models to determine our overall enterprise valuation and to evaluate acquisition targets. We believe OIBDA and OIBDA Margin are useful measures to evaluate our ability to grow our revenues faster than our operating expenses and they are an integral part of our internal reporting system utilized by management to assess and evaluate the operating performance of our business. OIBDA does
not include certain items, specifically (1) minority interest in earnings (losses) of subsidiaries, net and (2) other (income) expense, net, that we believe are not indicative of our core operating results. OIBDA also does not include interest expense, net and the provision for income taxes. These expenses are associated with our capitalization and tax structures, which management does not consider when evaluating the profitability of our core operations. Finally, OIBDA does not include depreciation and amortization expenses, in order to eliminate the impact of capital investments, which management believes is better evaluated by comparing capital expenditures to incremental revenue generated and as a percentage of total revenues. OIBDA and OIBDA Margin should be considered in addition to, but not as a substitute for, other measures of financial performance reported in accordance with GAAP such as operating or net income or cash flows from operating activities (as determined in accordance with GAAP).
Reconciliation of OIBDA to Operating Income and Net Income (In Thousands):
OIBDA
127,271
147,875
377,532
424,969
Less: Interest Expense, Net
Minority Interest
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 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, including those related to the allowance for doubtful accounts and credit memos, impairments of tangible and intangible assets, income taxes, purchase accounting related reserves, self-insurance liabilities, incentive compensation liabilities, litigation liabilities and contingencies. 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. We use these estimates to assist us in the identification and assessment of the accounting treatment necessary with respect to commitments and contingencies. Actual results may differ from these estimates. Our critical accounting policies include the following, which are listed in no particular order:
· Accounting for Acquisitions
· Allowance for Doubtful Accounts and Credit Memos
· Accounting for Derivative Instruments and Hedging Activities
· Accounting for Internal Use Software
· Deferred Income Taxes
· Stock-based Compensation
30
· Self-Insured Liabilities
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” and the consolidated financial statements and the notes included in our Annual Report on Form 10-K for the year ended December 31, 2004 as filed with the SEC. Management has determined that no material changes concerning our critical accounting policies have occurred since December 31, 2004.
Recent Accounting Pronouncements
In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123R, “Share-Based Payment.” SFAS No. 123R is a revision of SFAS No. 123 and supersedes Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB No. 25”). We adopted the measurement provisions of SFAS No. 123 and SFAS No. 148 in our financial statements beginning January 1, 2003 using the prospective method. The prospective method involves recognizing expense for the fair value for all awards granted or modified in the year of adoption and thereafter with no expense recognition for previous awards. We have applied the fair value recognition provisions to all stock based awards granted, modified or settled on or after January 1, 2003.
We expect to adopt SFAS No. 123R effective January 1, 2006 using the modified prospective method of implementation. Subject to a complete review of the requirements of SFAS No. 123R, based on outstanding stock options granted to employees prior to our prospective implementation of the measurement provisions of SFAS No. 123 and SFAS No. 148 on January 1, 2003, we expect to record $0.9 million of stock compensation expense in 2006 associated with unvested stock option grants issued prior to January 1, 2003.
31
Overview
The following discussions set forth, for the periods indicated, management’s discussion and analysis of results. Significant trends and changes are discussed for the three and nine month periods ended September 30, 2005 within each section, except in instances where the trend or explanation of the change is consistent for both periods reported. In those instances, only the trend or explanation for the change of the year-to-date period is discussed.
Results of Operations
Comparison of Three and Nine Months Ended September 30, 2005 to Three and Nine Months Ended September 30, 2004 (in thousands):
Dollar
Percent
Change
Revenues
67,142
14.6
Operating Expenses
49,967
13.3
17,175
20.2
Other Expenses, Net
66,552
65,800
(752
(1.1
)%
17,927
97.2
OIBDA(1)
20,604
16.2
OIBDA Margin(1)
27.7
28.1
201,138
15.0
168,778
15.6
32,360
12.6
193,316
205,244
11,928
6.2
20,432
31.8
47,437
28.2
27.6
(1) See “Non-GAAP Measures—Operating Income Before Depreciation and Amortization, or OIBDA” for definition, reconciliation and a discussion of why we believe these measures provide relevant and useful information to our current and potential investors.
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REVENUES
Our consolidated storage revenues increased $32.9 million, or 12.5%, to $296.8 million and $105.6 million, or 13.7%, to $873.8 million for the three and nine months ended September 30, 2005 compared to the same periods in 2004, respectively. For the three months ended September 30, 2005, the increase is attributable to internal revenue growth (9%) resulting from net increases in records and other media stored by existing customers and sales to new customers, acquisitions (3%), and foreign currency exchange rate fluctuations (1%). For the nine months ended September 30, 2005, the increase is attributable to internal revenue growth (9%) resulting from net increases in records and other media sales by existing customers and sales to new customers, acquisitions (4%), and foreign currency exchange rate fluctuations (1%).
Consolidated service and storage material sales revenues increased $34.2 million, or 17.5%, to $229.7 million and $95.6 million, or 16.8%, to $666.0 million for the three and nine months ended September 30, 2005 compared to the same periods in 2004, respectively. For the three months ended September 30, 2005, the increase is attributable to internal revenue growth (12%) resulting from net increases in service and storage material sales to existing customers, including a significant data restoration project in our digital business, and sales to new customers, acquisitions (5%), and foreign currency exchange rate fluctuations (1%). For the nine months ended September 30, 2005, the increase is attributable to acquisitions (8%), internal revenue growth (7%) resulting from net increases in service and storage material sales to existing customers and sales to new customers, and foreign currency exchange rate fluctuations (2%).
For the reasons stated above, our consolidated revenues increased $67.1 million, or 14.6%, to $526.5 million and $201.1 million, or 15.0%, to $1,539.8 million for the three and nine months ended September 30, 2005 compared to the same periods in 2004, respectively. Foreign currency exchange rate fluctuations that impacted our revenues were primarily due to the strengthening of the British pound sterling, the Euro and the Canadian dollar, against the U.S. dollar, based on an analysis of weighted average rates for the comparable periods. Internal revenue growth was 10% and 8% for the three and nine months ended September 30, 2005, respectively. We calculate internal revenue growth in local currency for our international operations.
Internal Growth—Eight-Quarter Trend
2003
FourthQuarter
FirstQuarter
SecondQuarter
ThirdQuarter
Storage Revenue
Service and Storage Material Sales Revenue
1
Total Revenue
Our internal revenue growth rate represents the weighted average year over year growth rate of our revenues after removing the effects of acquisitions and foreign currency exchange rate fluctuations. Over the past eight quarters, the internal growth rate of our storage revenues has consistently ranged between 8% and 9%. Our storage revenue internal growth rate trend over that period reflects stabilized net carton volume growth in our North American records management business and strong growth rates in our digital and certain international businesses. Net carton volume growth is a function of the rate new cartons are added by existing and new customers offset by the rate of carton destructions and other permanent removals.
The internal growth rate for service and storage material sales revenue is inherently more volatile than the storage revenue internal growth rate due to the more discretionary nature of the services we offer such as large special projects or data products and carton sales, as well as the price of recycled paper. These revenues are often event driven and impacted to a greater extent by economic downturns as customers may defer or cancel the purchase of these services as a way to reduce their short-term costs. As a commodity, recycled paper prices are subject to the volatility of that market. The internal growth rate over the past three quarters for service and storage material sales revenues reflects the following: (1) a large data restoration project in our digital business; (2) strong data product sales; (3) growth in North American storage related service revenue; (4) continued growth in our secure shredding business; and (5) improved growth rates in our data protection business. These positive factors were partially offset by: (1) lower special project revenues related to the public sector business in the UK; and (2) a large software license sale in the first quarter of 2004 that did not repeat in the first quarter of 2005.
OPERATING EXPENSES
Cost of Sales
Consolidated cost of sales (excluding depreciation) is comprised of the following expenses (in thousands):
Three Months Ended
% of
September 30,
Consolidated Revenues
Percent Change
(Favorable)/Unfavorable
Labor
107,538
111,434
3,896
3.6
23.4
21.2
(2.2
Facilities
62,582
68,221
5,639
9.0
13.6
13.0
(0.6
Transportation
21,085
25,280
4,195
19.9
4.6
4.8
0.2
Product Cost of Sales
8,207
13,822
5,615
68.4
1.8
2.6
0.8
10,385
18,657
8,272
79.7
2.3
3.5
1.2
27,617
13.2
45.7
45.1
Nine Months Ended
311,783
334,304
22,521
7.2
23.3
21.7
(1.6
184,143
204,198
20,055
10.9
13.8
(0.5
59,705
71,927
12,222
20.5
4.5
4.7
25,439
37,461
12,022
47.3
1.9
2.4
0.5
27,864
48,240
20,376
73.1
2.1
3.1
1.0
87,196
14.3
45.5
45.2
(0.3
For the nine months ended September 30, 2005 as compared to the nine months ended September 30, 2004, labor expense decreased as a percentage of consolidated revenues as a result of strong revenue growth, labor management controls implemented in the fourth quarter of 2004 in our North American operations, and an increasing proportion of revenue from less labor intensive digital services and product sales. We have also experienced improvement in our ratio of labor costs to revenues in our European operations as a result of completing the integration of Hays plc (“Hays IMS”) in 2004.
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Facilities costs as a percentage of consolidated revenues decreased to 13.3% for the nine months ended September 30, 2005 from 13.8% for the nine months ended September 30, 2004. The decrease in facilities costs as a percentage of consolidated revenues was primarily a result of decreasing base rent per square foot in our North American operations during 2004 and into 2005. The largest component of our facilities cost is rent expense, which increased $9.3 million for the nine months ended September 30, 2005 compared to the nine months ended September 30, 2004 primarily as a result of properties under lease acquired through acquisitions in both Europe and North America.
Our transportation expenses, which increased 0.2% as a percentage of consolidated revenues for the nine months ended September 30, 2005 compared to the nine months ended September 30, 2004, are influenced by several variables including total number of vehicles, owned versus leased vehicles, use of subcontracted couriers, fuel expenses and maintenance. Higher fuel expenses during the nine months ended September 30, 2005 compared to the nine months ended September 30, 2004 were primarily responsible for the increase in transportation expenses as a percentage of consolidated revenues.
Product and Other Cost of Sales
Product and other cost of sales are highly correlated to complementary revenue streams. Product and other cost of sales for the nine months ended September 30, 2005 were higher than the nine months ended September 30, 2004 as a percentage of consolidated revenues due to increased sales of data products at lower margins in North America, increased royalty payments associated with our electronic vaulting revenues and increases in technology costs associated with these revenue producing activities.
Selling, General and Administrative Expenses
Selling, general and administrative expenses are comprised of the following expenses (in thousands):
General and Administrative
64,222
71,032
6,810
10.6
14.0
13.5
Sales, Marketing & Account Management
40,426
44,749
4,323
10.7
8.8
8.5
Information Technology
20,348
25,438
5,090
25.0
4.4
0.4
Bad DebtExpense
(2,488
223
2,711
(109.0
18,934
15.5
26.9
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Nine Months
Ended September 30,
191,480
211,312
19,832
10.4
13.7
108,627
131,430
22,803
21.0
8.1
56,970
73,386
16,416
28.8
4.3
(3,621
1,967
5,588
(154.3
0.1
64,639
18.3
26.4
27.2
The decrease in general and administrative expenses as a percentage of consolidated revenues for the nine months ended September 30, 2005 compared to the nine months ended September 30, 2004 is attributable to strong revenue growth and controls over overhead spending implemented in late 2004. These decreases were partially offset by increased incentive compensation expense and growth of our European operations due to expansion and acquisitions.
The majority of our sales, marketing and account management costs are labor related and are primarily driven by the headcount in each of these departments. Increased headcount and related compensation and commissions are the most significant contributors to the increase in sales and marketing expenses as a percentage of revenues for the nine months ended September 30, 2005. Throughout 2004, we added sales and marketing employees, enlarged our account management force, and continued several new marketing and promotional efforts to develop awareness in the marketplace of our entire service offerings. The costs associated with these efforts contributed to the increase in our sales, marketing and account management expenses. Costs associated with our European sales and account management teams increased by $6.4 million for the nine months ended September 30, 2005, due to the expansion of our sales force through the hiring of new personnel and acquisitions. In addition, our larger North American sales force generated a $9.7 million increase in compensation for the nine months ended September 30, 2005 compared to the nine months ended September 30, 2004.
The decrease of sales, marketing, and account management expenses as a percentage of consolidated revenues for the three months ended September 30, 2005, compared to the three months ended September 30, 2004, is attributable to strong revenue growth and a decrease in account management costs in our records management and digital businesses in North America during 2005.
Information technology expenses increased as a percentage of consolidated revenues for the nine months ended September 30, 2005 compared to the nine months ended September 30, 2004 due to increases in internal software development projects within our digital business, the acquisition of Connected Corporation (“Connected”) and associated research and development activities, and increased information technology spending in our European operations. Higher utilization of existing information technology resources to revenue producing projects partially offset this increase.
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Bad Debt Expense
The increase in consolidated bad debt expense for the nine months ended September 30, 2005 compared to the nine months ended September 30, 2004 is primarily attributable to increased bad debt expense in our European operations represented by increases in days sales outstanding as a result of our recent relocation of our U.K. credit and collections team.
Depreciation, Amortization and (Gain) Loss on Disposal/Writedown of Property, Plant and Equipment, Net
Consolidated depreciation and amortization expense increased $15.1 million to $135.0 million (8.8% of consolidated revenues) for the nine months ended September 30, 2005 from $119.9 million (9.0% of consolidated revenues) for the nine months ended September 30, 2004. Depreciation expense increased $10.6 million for the nine months ended September 30, 2005 compared to the same period in 2004 primarily due to the additional depreciation expense related to recent capital expenditures and acquisitions, including storage systems, which include racking, building and leasehold improvements, computer systems hardware and software, and buildings. Amortization expense increased $4.4 million for the nine months ended September 30, 2005 compared to the same period in 2004 primarily due to amortization of intangible assets such as customer relationship intangible assets and intellectual property acquired through business combinations, including the Connected acquisition in November 2004. We expect that amortization expense will continue to increase as we acquire new businesses and reflect the recent buyouts of our minority interest partners.
Consolidated losses on disposal/writedown of property, plant and equipment, net of $0.6 million for the nine months ended September 30, 2005, consisted primarily of software asset writedowns. Consolidated gains on disposal/writedown of property, plant and equipment, net of $1.3 million for the nine months ended September 30, 2004 consisted primarily of a gain on the sale of a property in Florida during the second quarter of 2004 of $1.2 million. We will record a gain of approximately $4.5 million associated with the sale of a facility in the U.K. in the fourth quarter of 2005.
OPERATING INCOME
As a result of the foregoing factors, consolidated operating income increased $17.2 million, or 20.2%, to $102.2 million (19.4% of consolidated revenues) for the three months ended September 30, 2005 from $85.0 million (18.5% of consolidated revenues) for the three months ended September 30, 2004. Consolidated operating income increased $32.4 million, or 12.6%, to $290.0 million (18.8% of consolidated revenues) for the nine months ended September 30, 2005 from $257.6 million (19.2% of consolidated revenues) for the nine months ended September 30, 2004.
As a result of the foregoing factors, consolidated OIBDA increased $20.6 million, or 16.2% to $147.9 million (28.1% of consolidated revenues) for the three months ended September 30, 2005 from $127.3 million (27.7% of consolidated revenues) for the three months ended September 30, 2004. Consolidated OIBDA increased $47.4 million, or 12.6% to $425.0 million (27.6% of consolidated revenues) for the nine months ended September 30, 2005 from $377.5 million (28.2% of consolidated revenues) for the nine months ended September 30, 2004.
OTHER EXPENSES, NET
Consolidated interest expense, net decreased $10.0 million to $44.3 million (8.4% of consolidated revenues) and $3.1 million to $137.3 million (8.9% of consolidated revenues) for the three and nine
37
months ended September 30, 2005, respectively, from $54.3 million (11.8% of consolidated revenues) and $140.4 million (10.5% of consolidated revenues) for the three and nine months ended September 30, 2004, respectively. The dollar decrease in interest expense, net was primarily due to the recording of interest expense totaling $8.5 million for the nine months ending September 30, 2004, compared to interest income of $3.6 million for the nine months ending September 30, 2005 related to the net impact of mark-to-market adjustments and cash payments on the interest rate swap associated with a real estate term loan we repaid in August 2004. We did not terminate this swap and have recorded changes to the fair market value of the derivative liability to interest expense, net.
In addition to the impact of the mark-to-market adjustments, we increased borrowings primarily from entering into an additional $150.0 million of term loans in November 2004, as permitted under our IMI Credit Agreement, that partially offset the decrease in interest expense.
Other Expense (Income), Net (in thousands)
Foreign currency transaction (income) losses, net
(2,753
(5,745
(2,992
2,185
4,009
1,824
Debt extinguishment expense
(29
(2,454
(255
(797
(403
(942
(539
(3,563
(1,169
Foreign currency gains of $5.7 million based on period-end exchange rates were recorded in the three months ended September 30, 2005, primarily due to the strengthening of the Canadian dollar against the U.S. dollar partially offset by the weakening of the British pound sterling and Euro against the U.S. dollar, during the three month period. These third quarter gains reduced the year-to-date losses of $9.8 million recorded in the six months ended June 30, 2005 primarily due to the weakening of the British pound sterling, the Euro, and the Canadian dollar against the U.S. dollar as these currencies relate to our intercompany balances with and between our U.K., Canadian and European subsidiaries, and British pounds sterling denominated debt held by our U.S. parent company.
During the three months ended September 30, 2004, foreign currency gains of $2.8 million based on period-end exchange rates were recorded primarily due to the strengthening of the Canadian dollar against the U.S. dollar partially offset by the weakening of the British pound sterling against both the Euro and the U.S. dollar. These third quarter gains reduced the year-to-date losses of $4.9 million recorded in the six months ended June 30, 2004 primarily due to the weakening of the Canadian dollar against the U.S dollar and weakening of the British pound sterling against the Euro offset by the strengthening of the British pound sterling against the U.S. dollar as these currencies relate to our intercompany balances with and between our Canadian, U.K. and European subsidiaries, U.S. dollar denominated debt previously held by our Canadian subsidiary, borrowings denominated in foreign currencies under our U.S. revolving credit facility, British pounds sterling denominated debt held by our U.S. parent company, British pounds sterling currency held in the U.S. and our British pound sterling denominated cross currency swap, which was terminated in March 2004.
During the three months ended March 31, 2004, we redeemed the remaining outstanding principal amount of the 81¤8% Senior Notes due 2008 of our Canadian subsidiary, resulting in a charge of $2.0 million, and we repaid a portion of our real estate term loans, which resulted in a charge of $0.4 million. The charges consisted primarily of the call and tender premiums associated with the extinguished debt and the write-off of unamortized deferred financing cost and discounts.
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PROVISION FOR INCOME TAXES
Our effective tax rates for the three months ended September 30, 2004 and 2005 were 42.5% and 42.9%, respectively. Our effective tax rates for the nine months ended September 30, 2004 and 2005 were 41.3% and 42.6%, respectively. The primary reconciling item between the statutory rate of 35% and our effective rate is state income taxes (net of federal benefit). We are subject to income taxes in both the U.S. and numerous foreign jurisdictions. Significant judgment is required in determining our worldwide provision for income taxes. In the ordinary course of our business, there are many transactions and calculations where the ultimate tax determination is uncertain. Although we believe our tax estimates are reasonable, the final determination of tax audits and any related litigation could be materially different than that which is reflected in historical income tax provisions and accruals. Additional taxes assessed as a result of an audit or litigation could have a material effect on our income tax provision and net income in the period or periods in which that determination is made.
MINORITY INTEREST
Minority interest in earnings of subsidiaries, net resulted in a charge to income of $0.4 million and $1.1 million (0.1% of consolidated revenues) for the three and nine months ended September 30, 2005, respectively, compared to $0.9 million (0.2% of consolidated revenues) and $2.0 million (0.1% of consolidated revenues) for the three and nine months ended September 30, 2004, respectively. This represents our minority partners’ share of earnings in our majority-owned international subsidiaries that are consolidated in our operating results.
NET INCOME
As a result of the foregoing factors, consolidated net income increased $17.9 million, or 97.2%, to $36.4 million (6.9% of consolidated revenues) for the three months ended September 30, 2005 from net income of $18.5 million (4.0% of consolidated revenues) for the three months ended September 30, 2004. For the nine months ended September 30, 2005, consolidated net income increased $20.4 million, or 31.8%, to $84.7 million (5.5% of consolidated revenues) from net income of $64.3 million (4.8% of consolidated revenues) for the nine months ended September 30, 2004.
Segment Analysis (in thousands)
The results of our various operating segments are discussed below. In general, our business records management segment offers records management, secure shredding, healthcare information services, vital records services, and service and courier operations in the U.S. and Canada. Our data protection segment offers data backup and disaster recovery services, vital records services, service and courier operations, and intellectual property management services in the U.S. Our international segment offers elements of all our product and services lines outside the U.S. and Canada. Our corporate and other segment includes our corporate overhead functions and our fulfillment, consulting, digital archiving and PC/desktop computing electronic vaulting services.
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Business Records Management
Segment Revenue
Percentage
Segment Contribution(1)
Segment Contributionas a Percentage ofSegment Revenue
September 30,2004
Increase inRevenues
24,112
8.6
25.5
76,797
9.3
27.0
28.5
Items Excluded from the Calculation of Contribution(1)
Depreciation andAmortization
Foreign Currency (Gains)Losses, Net
Loss (Gain) on Disposal/Writedown of Property,Plant and Equipment, Net
Loss onDebt Extinguishment
Three MonthsEnded
21,551
19,642
(5,439
(5,443
(168
Nine MonthsEnded
62,080
59,596
1,055
(3,688
(1,304
(368
2,028
(1) See Note 8 of Notes to Consolidated Financial Statements for definition of Contribution and for the basis on which allocations are made and a reconciliation of Contribution to net income on a consolidated basis.
During the three and nine months ended September 30, 2005, revenue in our business records management segment increased 8.6% and 9.3%, respectively, compared to the three and nine months ended September 30, 2004, primarily due to growth in storage volumes and associated service revenues, growth of our secure shredding operations and acquisitions. In addition, favorable currency fluctuations during the nine months ended September 30, 2005 in Canada increased revenue, as measured in U.S. dollars, by $7.6 million when compared to the nine months ended September 30, 2004. Contribution as a percent of segment revenue increased due to strong revenue growth, the effectiveness of recent labor and cost management initiatives and lower bad debt expense, which were partially offset by increases in transportation and facility related expenses.
Data Protection
13,694
19.5
28.6
30.8
32,896
16.1
28.7
29.7
(Gain)/Loss on Disposal/Writedown of Property,Plant and Equipment, Net
3,909
3,892
(109
10,691
11,480
(21
(7
During the three and nine months ended September 30, 2005, revenue in our data protection segment increased 19.5% and 16.1%, respectively, compared to the three and nine months ended September 30, 2004 primarily due to higher internal growth rates from our product sales and electronic vaulting services which were supported by improved internal growth rates in our core data protection business. Contribution as a percent of segment revenue increased primarily due to strong revenue growth, labor and cost
management initiatives and was partially offset by decreased product sales margins and the growth of our sales and account management force including higher sales commissions. Bad debt expense for the three and nine months ended September 30, 2005 was higher than the three and nine months ended September 30, 2004.
SegmentContribution(1)
6,441
6.5
24.2
26.8
41,907
24.5
25.3
Foreign CurrencyLosses (Gains), Net
8,875
10,682
3,103
(1,472
23,696
35,482
7,150
3,343
67
(130
Revenue in our international segment increased 6.5% and 15.0% during the three and nine months ended September 30, 2005, respectively, compared to the three and nine months ended September 30, 2004, primarily due to acquisitions completed in Europe and in South America and strong internal growth in Latin America, offset by lower revenue in our U.K public sector business. Favorable currency fluctuations during the nine months ended September 30, 2005 in Europe, Mexico and South America increased revenue, as measured in U.S. dollars, by $13.4 million compared to the nine months ended September 30, 2004. Contribution as a percent of segment revenue increased primarily due to improvements in both cost of sales and overhead labor ratios as a result of completing the integration of Hays IMS in the second half of 2004 offset by increased compensation associated with additional sales, marketing, and account management personnel, several new marketing and promotional efforts, and increased bad debt expense.
Corporate and Other
The Corporate and Other segment is comprised of results from operations not discussed above, including our digital archiving services, PC/Desktop computing electronic vaulting services, consulting and fulfillment operations and costs associated with our corporate headquarters’ operations. Certain costs incurred by our Corporate division were allocated to the other segments in the three and nine months ended September 30, 2004 and 2005, primarily to our Business Records Management and Data Protection segments. These allocations, which include rent, worker’s compensation, property, general liability, auto and other insurance, pension/medical costs, incentive compensation, real estate property taxes and provision for bad debts, are based on rates set at the beginning of each year.
Revenue in our Corporate and Other segment increased $22.9 million to $34.0 million for the three months ended September 30, 2005 compared to $11.1 million for the three months ended September 30, 2004 and $49.5 million to $80.6 million for the nine months ended September 30, 2005 compared to $31.1 million for the nine months ended September 30, 2004. The dollar increases were due primarily to strong internal growth in our digital business, including a large data restoration project and the acquisition of Connected in November 2004.
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Contribution decreased $3.9 million to $8.1 million for the three months ended September 30, 2005 compared to $11.9 million for the three months ended September 30, 2004 and decreased $10.0 million to $17.1 million for the nine months ended September 30, 2005 compared to $27.1 million for the nine months ended September 30, 2004. Items excluded from the calculation of Contribution include the following: (1) depreciation and amortization expense for the three months ended September 30, 2004 of $7.9 million compared to $11.5 million for the three months ended September 30, 2005 and depreciation and amortization expense for the nine months ended September 30, 2004 of $23.4 million compared to $28.4 million for the nine months ended September 30, 2005, (2) foreign currency gains of $0.4 million and losses $1.2 million for the three months ended September 30, 2004 and 2005, respectively, and foreign currency gains of $6.0 million and foreign currency losses of $4.4 million for the nine months ended September 30, 2004 and 2005, respectively, (3) debt extinguishment expenses of $0.4 million for the nine months ended September 30, 2004, and (4) losses on disposal/writedown of property, plant and equipment, net for the three months ended September 30, 2004 of $1.9 million compared to zero for the three months September 30, 2005 and a gain on disposal/writedown of property, plant and equipment, net for the nine months ended September 30, 2004 of $1.8 million compared to a loss of $1.1 million for the nine months ended September 30, 2005.
Liquidity and Capital Resources
The following is a summary of our cash balances and cash flows for the nine months ended September 30, 2004 and 2005 (in thousands).
Cash flows provided by operating activities
Cash flows used in investing activities
Cash flows provided by (used in) financing activities
Cash and cash equivalents at the end of period
Net cash provided by operating activities was $278.9 million for the nine months ended September 30, 2005 compared to $209.0 million for the nine months ended September 30, 2004, an increase of 33.4%. The increase resulted primarily from increases net income and the net change in assets and liabilities. The net change in assets and liabilities is primarily associated with increases in accounts receivable, payroll and incentive compensation related accruals, and the deferred tax liability offset by a decrease in the deferred tax assets.
Our capital expenditures are primarily related to growth and include investments in storage systems, information systems and discretionary investments in real estate. Cash paid for our (a) capital expenditures and (b) additions to customer relationship and acquisition costs during the nine months ended September 30, 2005 amounted to $189.7 million and $10.0 million, respectively. For the nine months ended September 30, 2005, capital expenditures, net and additions to customer relationship and acquisition costs were funded entirely with cash flows provided by operating activities. We received $8.3 million of net cash proceeds from the sale of certain internet technology equipment in connection with a sale-leaseback transaction completed in the third quarter of 2005. In the fourth quarter of 2005, we expect to receive approximately $20 million in net cash proceeds associated with the sale of three real estate facilities. Excluding acquisitions, we expect our capital expenditures to be between approximately $250 million and approximately $275 million in the year ending December 31, 2005.
In the nine months ended September 30, 2005, we paid net cash consideration of $46.1 million for acquisitions, which included $19 million to purchase our minority partners equity interest in certain of our Latin American subsidiaries. Cash flows from operations and borrowings under our revolving credit facilities funded these acquisitions.
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Net cash used in financing activities was ($30.8 million) for the nine months ended September 30, 2005. During the nine months ended September 30, 2005, we had gross borrowings under our revolving credit facilities and term loan facilities of $396.6 million. We used the proceeds from these financing transactions and cash flows from operations to repay debt and term loans ($441.4 million) and to repay debt financing from minority shareholders, net ($2.0 million).
We are highly leveraged and expect to continue to be highly leveraged for the foreseeable future. Our consolidated debt as of September 30, 2005 was comprised of the following (in thousands):
IME Revolving Credit Facility
IME Term Loan Facility
81¤4% Senior Subordinated Notes due 2011(1)
85¤8% Senior Subordinated Notes due 2013(1)
71¤4% GBP Senior Subordinated Notes due 2014(1)
73¤4% Senior Subordinated Notes due 2015(1)
65¤8% Senior Subordinated Notes due 2016(1)
Real Estate Mortgages
Seller Notes
(1) These debt instruments are fully and unconditionally guaranteed, on a senior subordinated basis, by substantially all of our direct and indirect wholly owned U.S. subsidiaries (the “Guarantors”). These guarantees are joint and several obligations of the Guarantors. The remainder of our subsidiaries do not guarantee these notes or the IMI revolving credit facility and IMI term loan facility.
Our indentures use OIBDA-based calculations as primary measures of financial performance, including leverage ratios. Our key bond leverage ratio, as calculated per our bond indentures, was 5.0 and 4.5 as of December 31, 2004 and September 30, 2005, respectively. Noncompliance with this leverage ratio would have a material adverse effect on our financial condition and liquidity. Our target for this ratio is generally in the range of 4.5 to 5.5 while the maximum ratio allowable under the bond indentures is 6.5.
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.
Our consolidated balance sheet as of September 30, 2005 includes 100.0 million British pounds sterling and 69.8 million Euro of borrowings (totaling approximately $260.5 million) of borrowings under the IME Credit Agreement. The remaining availability, based on its current level of external debt and the leverage ratio under the IME revolving credit facility on July 31, 2005, was approximately 38.4 million British pounds sterling (approximately $67.7 million). The interest rate in effect under the IME revolving credit facility ranged from 3.6% to 6.2% as of July 31, 2005.
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As of September 30, 2005, we had $102.5 million of borrowings under the IMI revolving credit facility, all of which were denominated in Canadian dollars (CAD 120.0 million); we also had various outstanding letters of credit totaling $24.0 million. The remaining availability, based on IMI’s current level of external debt and the leverage ratio under the IMI revolving credit facility, on September 30, 2005 was $223.6 million. The interest rate in effect under the IMI revolving credit facility was 4.6% as of September 30, 2005.
The IME Credit Agreement, IMI Credit Agreement and 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 IME Credit Agreement, IMI Credit Agreement and our indentures and other agreements governing our indebtedness. We were in compliance with all material debt covenants as of September 30, 2005.
We expect to pay cash taxes of approximately $10 million in the fourth quarter of 2005.
In October 2005, we signed a definitive agreement to acquire the Australian and New Zealand operations of Pickfords Records Management for total cash consideration of approximately Australian Dollar 115.0 million (US$87.0 million). The transaction is subject to customary closing conditions and regulatory approvals and is expected to be completed by year end.
We expect to meet our cash flow requirements for the next twelve months from cash generated from operations, existing cash, cash equivalents and marketable securities, borrowings under the IMI revolving credit facility and other financings, which may include secured credit facilities, securitizations and mortgage or capital lease financings. See Note 6 to Notes to Consolidated Financial Statements.
Net Operating Loss Carryforwards
At September 30, 2005, we had estimated net operating loss carryforwards of approximately $108 million for federal income tax purposes. As a result of such loss carryforwards, cash paid for income taxes has historically been substantially lower than the provision for income taxes. These net operating loss carryforwards do not include approximately $103 million of potential preacquisition net operating loss carryforwards of Arcus Group, Inc. Any tax benefit realized related to preacquisition net operating loss carryforwards will be recorded as a reduction of goodwill when, and if, realized. The Arcus Group carryforwards begin to expire next year. As a result of these loss carryforwards, we do not expect to pay any significant U.S. federal and state income taxes in 2005.
Seasonality
Historically, our businesses have not been subject to seasonality in any material respect.
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 3. Quantitative and Qualitative Disclosures About Market Risk
Interest Rate Risk
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 helping to preserve our long term returns on invested capital. We target a range 80% to 85% of our debt portfolio to be fixed with respect to interest rates. Occasionally, we will use floating to fixed interest rate swaps as a tool to maintain our targeted level of fixed rate debt. As part of this strategy, in December 2000, January 2001, May 2001, and April 2004 we, IME, and variable interest entities we now consolidate, entered into a total of six derivative financial contracts, which are variable-for-fixed interest rate swaps consisting of (a) two contracts for interest payments payable on the IMI term loan facility of an aggregate principal amount of $195.5 million, (b) one contract, which expired in March 2005, based on interest payments previously payable on our real estate term loans of an aggregate principal amount of $47.5 million that have been subsequently repaid, (c) one contract based on interest payments previously payable on our real estate term loans of an aggregate principal amount of $97.0 million that have been subsequently repaid, and (d) two contracts for interest payments payable on IME’s term loan facility of an aggregate principal amount of 100.0 million British pounds sterling. See Note 4 to Notes to Consolidated Financial Statements and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies” in our Annual Report on Form 10-K for the year ended December 31, 2004.
After consideration of the swap contracts mentioned above, as of September 30, 2005, we had $349.5 million of variable rate debt outstanding with a weighted average variable interest rate of 5.5% and $2,058.9 million of fixed rate debt outstanding. As of September 30, 2005, 86% of our total debt outstanding was fixed. If the weighted average variable interest rate on our variable rate debt had increased by 1%, our net income for the three and nine months ended September 30, 2005 would have been reduced by $0.5 million and $1.4 million, respectively. See Note 6 to Notes to Consolidated Financial Statements included in this Form 10-Q for a discussion of our long-term indebtedness, including the fair values of such indebtedness as of September 30, 2005.
Currency Risk
Our investments in IME, Iron Mountain Canada Corporation (“IM Canada”), Iron Mountain Mexico, SA de RL de CV, Iron Mountain South America, Ltd. and other international investments may be subject to risks and uncertainties related to fluctuations in currency valuation. Our reporting currency is the U.S. dollar. However, our international revenues and expenses are generated in the currencies of the countries in which we operate, primarily the Canadian dollar, British pound sterling and the Euro. The currencies of many Latin American countries, particularly the Argentine peso, have experienced substantial volatility and depreciation. Declines in the value of the local currencies in which we are paid relative to the U.S. dollar will cause revenues in U.S. dollar terms to decrease and dollar-denominated liabilities to increase in local currency. The impact on our earnings is mitigated somewhat by the fact that most operating and other expenses are also incurred and paid in the local currency. We also have several intercompany obligations between our foreign subsidiaries and Iron Mountain and our U.S.-based subsidiaries. These intercompany obligations are primarily denominated in the local currency of the foreign subsidiary.
We have adopted and implemented a number of strategies to mitigate the risks associated with fluctuations in currency valuations. One strategy is to finance our largest international subsidiaries with local debt that is denominated in local currencies, thereby providing an economic hedge. In determining the amount of any such financing, we take into account local tax strategies among other factors. Another strategy we utilize is to borrow in foreign currencies at the U.S. parent level to hedge our intercompany
financing activities. Finally, on occasion, we enter into currency swaps to temporarily hedge an overseas investment, such as a major acquisition to lock in certain transaction economics, while we arrange permanent financing. We have implemented these strategies for our two major foreign investments in the U.K. and Canada, specifically, through IME borrowing under the IME Credit Agreement and our 150 million British pounds sterling denominated 71¤4% senior subordinated notes, which effectively hedges most of our outstanding intercompany loan with IME. With respect to Canada, in August 2004, we repaid the remaining $98.7 million of real estate term loans by having IM Canada draw on its portion of the IMI revolving credit facility in local currency and repaying a portion of its intercompany loan back to the U.S. parent. This has created an economic hedge on a portion of the intercompany balance and will reduce our currency fluctuations with regard to our investment in IM Canada while providing IM Canada with additional borrowings and interest expenses to reduce its income tax burden. As of September 30, 2005, except as noted above, our currency exposures to intercompany balances are unhedged.
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 required to be disclosed by a company in the reports that it files under the Exchange Act is recorded, processed, summarized and reported within required time periods. As of September 30, 2005 (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 September 30, 2005 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Part II. Other Information
Item 1. Legal Proceedings
There have been no material developments during the third quarter of 2005 in the proceedings described in our Annual Report on Form 10-K for the year ended December 31, 2004 other than the matters described in our Quarterly Reports on Form 10-Q for the quarters ended March 31, 2005 and June 30, 2005.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
The following table sets forth our common stock repurchased for the three months ended September 30, 2005:
Issuer Purchases of Equity Securities
Period
Total Numberof SharesPurchased(1)
Average PricePaid per Share
Total Number ofSharesPurchased as Partof PubliclyAnnounced Plansor Programs
Maximum Number(or ApproximateDollar Value) ofShares that May YetBe Purchased Underthe Plans orPrograms
September 1, 2005-September 30, 2005
6,156
36.26
(1) Consists of shares tendered by current and former employees, as payment of the exercise price of stock options granted, in accordance with provisions of our equity compensation plans and individual stock option agreements. No shares have been purchased other than as payment of the exercise price of stock options.
Item 6. Exhibits
(a) Exhibits
Exhibit No.
Description
31.1
Certification required by Rule 13a-14(a)/15(d)-14(a) of the Securities Exchange Act of 1934, as amended.
31.2
32.1
Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2
Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
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.
November 9, 2005
BY:
/s/ JOHN F. KENNY, JR.
(DATE)
John F. Kenny, Jr.
Executive Vice President,
Chief Financial Officer and Director
(Principal Financial Officer)