UNITED STATES
SECURITIES 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 March 31, 2006
Or
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE 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 of
(I.R.S. Employer
Incorporation or Organization)
Identification 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 a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of “large accelerated filer and accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer x
Accelerated filero
Non-accelerated filer 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 May 1, 2006: 131,892,422
Index
Page
PART I—FINANCIAL INFORMATION
Item 1—Unaudited Consolidated Financial Statements
Consolidated Balance Sheets at December 31, 2005 and March 31, 2006 (Unaudited)
3
Consolidated Statements of Operations for the Three Months Ended March 31, 2005 and 2006 (Unaudited)
4
Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2005 and 2006 (Unaudited)
5
Notes to Consolidated Financial Statements (Unaudited)
6
Item 2—Management’s Discussion and Analysis of Financial Condition and Results of Operations
28
Item 3—Quantitative and Qualitative Disclosures About Market Risk
40
Item 4—Controls and Procedures
42
PART II—OTHER INFORMATION
Item 1—Legal Proceedings
43
Item 2—Unregistered Sales of Equity Securities and Use of Proceeds
Item 6—Exhibits
Signature
44
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,
March 31,
2005
2006
ASSETS
Current Assets:
Cash and cash equivalents
$
53,413
42,552
Accounts receivable (less allowances of $14,522 and $13,366, respectively)
408,564
421,936
Deferred income taxes
27,623
27,165
Prepaid expenses and other
64,568
71,440
Total Current Assets
554,168
563,093
Property, Plant and Equipment:
Property, plant and equipment
2,556,880
2,627,264
Less—Accumulated depreciation
(775,614
)
(820,471
Net Property, Plant and Equipment
1,781,266
1,806,793
Other Assets, net:
Goodwill
2,138,641
2,131,372
Customer relationships and acquisition costs
229,006
232,050
Deferred financing costs
31,606
30,264
Other
31,453
33,785
Total Other Assets, net
2,430,706
2,427,471
Total Assets
4,766,140
4,797,357
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities:
Current portion of long-term debt
25,905
33,218
Accounts payable
148,234
113,612
Accrued expenses
266,720
246,358
Deferred revenue
151,137
157,349
Total Current Liabilities
591,996
550,537
Long-term Debt, net of current portion
2,503,526
2,531,267
Other Long-term Liabilities
33,545
33,573
Deferred Rent
35,763
38,863
Deferred Income Taxes
225,314
236,396
Commitments and Contingencies (see Note 9)
Minority Interests
5,867
4,672
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 131,662,871 shares and 131,845,641 shares, respectively)
1,317
1,318
Additional paid-in capital
1,105,604
1,111,812
Retained earnings
244,524
271,797
Accumulated other comprehensive items, net
18,684
17,122
Total Stockholders’ Equity
1,370,129
1,402,049
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 EndedMarch 31,
Revenues:
Storage
285,355
319,155
Service and storage material sales
216,051
244,502
Total Revenues
501,406
563,657
Operating Expenses:
Cost of sales (excluding depreciation)
230,628
262,368
Selling, general and administrative
135,340
158,843
Depreciation and amortization
44,546
49,848
(Gain) Loss on disposal/writedown of property, plant and equipment, net
(218
163
Total Operating Expenses
410,296
471,222
Operating Income
91,110
92,435
Interest Expense, Net
45,806
46,578
Other Expense (Income), Net
4,663
(2,847
Income Before Provision for Income Taxes and Minority Interest
40,641
48,704
Provision for Income Taxes
17,236
20,971
Minority Interest in Earnings of Subsidiaries, Net
456
460
Net Income
22,949
27,273
Net Income per Share—Basic
0.18
0.21
Net Income per Share—Diluted
0.17
0.20
Weighted Average Common Shares Outstanding—Basic
129,981
131,681
Weighted Average Common Shares Outstanding—Diluted
131,517
133,313
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, net
Depreciation
40,479
45,255
Amortization (includes deferred financing costs and bond discount of $1,206 and $1,232, respectively)
5,273
5,825
Stock compensation expense
1,043
2,706
Provision for deferred income taxes
14,092
14,357
Loss (Gain) on foreign currency and other, net
2,107
(3,823
Changes in Assets and Liabilities (exclusive of acquisitions):
Accounts receivable
(20,102
(9,721
Prepaid expenses and other current assets
(9,086
(6,222
(2,733
(13,616
Accrued expenses, deferred revenue and other current liabilities
8,148
(3,528
Other assets and long-term liabilities
1,006
2,869
Cash Flows from Operating Activities
63,414
61,998
Cash Flows from Investing Activities:
Capital expenditures
(58,646
(73,677
Cash paid for acquisitions, net of cash acquired
(33,213
(23,367
Additions to customer relationship and acquisition costs
(2,883
(2,978
Investment in joint ventures
(3,098
Other, net
271
(745
Cash Flows from Investing Activities
(94,471
(103,865
Cash Flows from Financing Activities:
Repayment of debt and term loans
(115,423
(177,445
Proceeds from debt and term loans
139,253
207,752
Debt financing (repayment to) and equity contribution from (distribution to) minority stockholders, net
(1,704
(1,270
Proceeds from exercise of stock options
5,386
2,168
Payment of debt financing costs and stock issuance costs
(58
(15
Cash Flows from Financing Activities
27,454
31,190
Effect of exchange rates on cash and cash equivalents
437
(184
Decrease in Cash and Cash Equivalents
(3,166
(10,861
Cash and Cash Equivalents, Beginning of Period
31,942
Cash and Cash Equivalents, End of Period
28,776
Supplemental Data:
Cash Paid for Interest
48,899
48,094
Cash Paid for Income Taxes
1,307
4,060
Non-Cash Investing Activities:
Capital Leases
105
4,289
Capital Expenditures
(21,362
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.
The consolidated balance sheet presented as of December 31, 2005 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, 2005.
(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 fiscal year ended October 31. 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 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, calculated as the difference between the historical exchange rate and the exchange rate at the applicable measurement date, including those related to (a) our 71¤4% GBP Senior Subordinated Notes due 2014 (the “71¤4% notes”), (b) the borrowings in certain foreign currencies under our revolving credit agreements, and (c) 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. The total of such net loss amounted to $4,789 and a net gain of $1,329 for the three months ended March 31, 2005 and 2006, 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
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)
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, 2005 and noted no impairment of goodwill. In making this assessment, we rely on a number of factors including operating results, business plans, economic projections, anticipated future cash flows, transactions and market place data. There are inherent uncertainties related to these factors and our judgment in applying them to the analysis of goodwill impairment. As of March 31, 2006, no factors were identified that would alter this assessment. Impairment adjustments recognized in the future, if any, will be recognized as operating expenses. Our operating segments at which level we performed our goodwill impairment analysis for the year ending December 31, 2005 were as follows: Business Records Management, Data Protection, Fulfillment, Digital Archiving Services, Europe, South America, Mexico and Asia Pacific. When changes occur in the composition of one or more operating segments, the goodwill is reassigned to the segments affected based on their relative fair value. Beginning January 1, 2006, we changed our reportable segments as a result of certain management and organizational changes within our North American business. Therefore, the presentation of all historical segment reporting has been changed to conform to our new management reporting. See Note 8 for more information regarding our changes in segment reporting.
Goodwill valuations have been calculated using an income approach based on the present value of future cash flows of each operating segment. This approach incorporates many assumptions including future growth rates, discount factors, expected capital expenditures and income tax cash flows. Changes in economic and operating conditions impacting these assumptions could result in goodwill impairments in future periods.
The changes in the carrying value of goodwill attributable to each reportable operating segment for the three month period ended March 31, 2006 are as follows:
NorthAmericanPhysicalBusiness
InternationalPhysicalBusiness
WorldwideDigitalBusiness
TotalConsolidated
Balance as of December 31, 2005
1,543,037
463,742
131,862
Deductible Goodwill acquired during the period
2,680
603
3,283
Nondeductible Goodwill acquired during the period
6,565
Adjustments to purchase reserves
(269
Fair value adjustments
(4
(13,534
361
(13,177
Currency effects and other adjustments
(1,196
(2,632
157
(3,671
Balance as of March 31, 2006
1,544,248
454,744
132,380
7
The components of our amortizable intangible assets at March 31, 2006 are as follows:
Gross Carrying
Accumulated
Net Carrying
Amount
Amortization
Customer Relationships and Acquisition Costs
271,344
39,294
Core Technology(1)
25,960
3,754
22,206
Non-Compete Agreements(1)
1,418
1,046
372
Deferred Financing Costs
46,676
16,412
Total
345,398
60,506
284,892
(1) Included in other assets, net in the accompanying consolidated balance sheet.
d. Stock-Based Compensation
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, “Accounting for Stock-Based Compensation,” as amended by SFAS No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure” 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.
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. We adopted SFAS No. 123R effective January 1, 2006 using the modified prospective method, as permitted under SFAS No. 123R. We record stock-based compensation expense for the cost of stock options, restricted stock and shares issued under the employee stock purchase plan (together, “Employee Stock-Based Awards”) based on the requirements of SFAS No. 123R beginning January 1, 2006 and based on the requirements of SFAS No. 123 for all unvested awards granted prior to January 1, 2006.
Stock-based compensation expense, included in the accompanying consolidated statements of operations, in the first quarter of 2006 was $2,706 ($1,658 after tax or $0.01 per basic and diluted share) and in the first quarter of 2005 was $1,043 ($859 after tax or $0.01 per basic and diluted share) for Employee Stock-Based Awards. In the first quarter of 2006, the incremental stock-based compensation expense due to the adoption of SFAS No. 123R caused income before provision for income taxes and minority interest to decrease by $297 and net income to decrease by $182 and had no impact on basic and diluted earnings per share.
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
8
as required under current rules, potentially reducing net operating cash flows and increasing net financing cash flows in future periods.
The following table details the effect on net income and earnings per share had stock-based compensation expense for the Employee Stock-Based Awards been recorded in the first quarter of 2005 based on SFAS No. 123R. The reported and pro forma net income and earnings per share for the first quarter of 2006 in the table below are the same since stock-based compensation expense is calculated under the provisions of SFAS No. 123R. These amounts for the first quarter of 2006 are included in the table below only to provide the detail for a comparative presentation to the first quarter of 2005.
Three Months EndedMarch 31, 2005
Three Months EndedMarch 31, 2006
Net income, as reported
Add: Stock-based employee compensation expense included in reported net income, net of tax benefit
859
1,658
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of tax benefit
(1,198
(1,658
Net income, pro forma
22,610
Earnings per share:
Basic—as reported
Basic—pro forma
Diluted—as reported
Diluted—pro forma
Stock Options
Under our various stock option plans, options were granted with exercise prices equal to the market price of the stock at the date of grant. The majority of our options become exercisable ratably over a period of five years and generally have a contractual life of 10 years, unless the holder’s employment is terminated. Our Directors are considered employees under the provisions of SFAS No. 123R.
9
The weighted average fair value of options granted for the three months ended March 31, 2005 and 2006 was $10.39 and $15.57 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
Expected volatility
27.5%
25.4%
Risk-free interest rate
3.96%
4.42%
Expected dividend yield
None
Expected life of the option
6.6 years
Expected volatility was calculated utilizing daily historical volatility over a period that equates to the expected life of the option. The risk-free interest rate was based on the U.S. Treasury yield curve in effect at the time of grant. Expected dividend yield was not considered in the option pricing model since we do not pay dividends and have no current plans to do so in the future. The expected life (estimated period of time outstanding) of the stock options granted was estimated using the historical exercise behavior of employees.
A summary of option activity for the three months ended March 31, 2006 is as follows:
Options
WeightedAverageExercisePrice
WeightedAverageRemainingContractualTerm
AggregateIntrinsicValue
Outstanding at December 31, 2005
5,495,274
22.41
Granted
166,457
41.98
Exercised
(182,301
13.34
Forfeited
(70,501
25.91
Outstanding at March 31, 2006
5,408,929
23.26
6.6
94,548
Options exercisable at March 31, 2006
2,646,819
15.67
4.6
66,356
The aggregate intrinsic value of stock options exercised during the three months ended March 31, 2006 was approximately $5,205.
Restricted Stock
Under our various stock option plans, we may also issue grants of restricted stock. We granted restricted stock in July 2005 which had a 3-year vesting period. The fair value of restricted stock is the excess of the market price of our common stock at the date of grant over the exercise price, which is zero. Included in our stock-based compensation expense in the first quarter of 2006 is a portion of the cost related to restricted stock granted in July 2005. We did not grant restricted stock in the first three months of 2006.
10
A summary of restricted stock activity for the three months ended March 31, 2006 is as follows:
RestrictedStock
Weighted-AverageGrant-DateFair Value
Non-vested at December 31, 2005
64,641
30.94
Vested
Non-vested at March 31, 2006
The total fair value of shares vested for the first quarter of 2006 was $0 as no shares vested during the period.
Employee Stock Purchase Plan
We offer an employee stock purchase plan in which participation is available to substantially all employees who meet certain service eligibility requirements (the “ESPP”). The ESPP provides a way for our eligible employees to become stockholders on favorable terms. The ESPP provides for the purchase of our common stock by eligible employees through successive offering periods. We generally have two 6-month offering periods, the first of which begins June 1 and ends November 30 and the second begins December 1 and ends May 31. During each offering period, participating employees accumulate after-tax payroll contributions, up to a maximum of 15% of their compensation, to pay the exercise price of their options. Participating employees may withdraw from an offering period before the purchase date and obtain a refund of the amounts withheld as payroll deductions. At the end of the offering period, outstanding options are exercised, and each employee’s accumulated contributions are used to purchase our common stock. The price for shares purchased under the ESPP is 85% of the fair market price at either the beginning or the end of the offering period, whichever is lower. In the three months ended March 31, 2005 and 2006, there were no offering periods which ended under the ESPP and no shares were issued.
11
The fair value of the ESPP offerings is estimated on the date of grant using a Black-Scholes option valuation model that uses the assumptions noted in the following table for the respective periods. Expected volatility was calculated utilizing daily historical volatility over a period that equates to the expected life of the option. The risk-free interest rate was based on the U.S. Treasury yield curve in effect at the time of grant. The expected life equates to the 6-month offering period over which employees accumulate payroll deductions to purchase our common stock. Expected dividend yield was not considered in the option pricing model since we do not pay dividends and have no current plans to do so in the future.
December 2004Offering
December 2005Offering
24.0%
26.6%
3.41%
4.04%
6 months
The weighted average fair value for the ESPP options was $6.07 and $8.70 for the December 2004 and December 2005 offerings, respectively.
As of March 31, 2006, unrecognized compensation cost related to the unvested portion of our Employee Stock-Based Awards was $23,848 and is expected to be recognized over a weighted-average period of 4.2 years.
We generally issue shares for the exercises of stock options, issuance of restricted stock and issuance of shares under our ESPP from unissued reserved shares.
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 1,536,016 and 1,632,348 shares for the three months ended March 31, 2005 and 2006, respectively. Potential common shares of 420,961 and 346,853 for the three months ended March 31, 2005 and 2006, respectively, have been excluded from the calculation of diluted net income per share, as their effects are antidilutive.
f. Revenue
Our revenues consist of storage revenues as well as service and storage material sales revenues. Storage revenues consist of periodic charges related to the storage of materials or data (generally on a per unit or per cubic foot of records basis). Service and storage material sales revenues are comprised of charges for related service activities and courier operations and the sale of software licenses and storage
12
materials. Related core service revenues arise from: (a) the handling of records including the addition of new records, temporary removal of records from storage, refiling of removed records, destruction of records, and permanent withdrawals from storage; (b) courier operations, consisting primarily of the pickup and delivery of records upon customer request; (c) secure shredding of sensitive documents; and (d) other recurring services including maintenance and support contracts. Our complementary services revenues arise from special project work, including data restoration; and providing fulfillment services, consulting services and product sales, including software licenses, specially designed storage containers, magnetic media including computer tapes and related supplies.
We recognize revenue when the following criteria are met: persuasive evidence of an arrangement exists, services have been rendered, the sales price is fixed or determinable, and collectability of the resulting receivable is reasonably assured. Storage and service revenues are recognized in the month the respective storage or service is provided and customers are generally billed on a monthly basis on contractually agreed-upon terms. Amounts related to future storage or prepaid service contracts, including maintenance and support contracts, for customers where storage fees or services are billed in advance are accounted for as deferred revenue and recognized ratably over the applicable storage or service period or when the service is performed. Storage material sales are recognized when shipped to the customer and include software license sales (less than 1% of consolidated revenues in the first quarter of 2006). Sales of software licenses to distributors are recognized at the time a distributor reports that the software has been licensed to an end-user and all revenue recognition criteria have been satisfied.
g. Use of Estimates
The preparation of financial statements in conformity with GAAP requires us to make estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities at the date of the financial statements and for the period then ended. On an on-going basis, we evaluate the estimates used, including those related to accounting for acquisitions, allowance for doubtful accounts and credit memos, impairments of tangible and intangible assets, income taxes, stock-based compensation and self-insured liabilities. We base our estimates on historical experience, actuarial estimates, current conditions and various other assumptions that we believe to be reasonable under the circumstances. These estimates form the basis for making judgments about the carrying values of assets and liabilities and are not readily apparent from other sources. Actual results may differ from these estimates.
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(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
2,355
(1,782
Market Value Adjustments for Hedging Contracts, Net of Tax
1,124
214
Market Value Adjustments for Securities, Net of Tax
Comprehensive Income
26,437
25,711
(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 which are subject to foreign exchange or other market price risk, and not for trading purposes. We have formally documented our hedging relationships, including identification of the hedging instruments and the hedged items, as well as our risk management objectives and strategies for undertaking each hedge transaction. Given the recurring nature of our revenues and the long term nature of our asset base, we have the ability and the preference to use long term, fixed interest rate debt to finance our business, thereby preserving our long term returns on invested capital. We target 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. 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. Sometimes we enter into currency swaps to temporarily hedge an overseas investment, such as a major acquisition, while we arrange permanent financing.
We entered into two interest rate swap agreements, which were derivatives as defined by SFAS No. 133 and designated as cash flow hedges. These swap agreements hedged interest rate risk on certain amounts of our term loan. As of March 31, 2006, both of these swap agreements had expired. Additionally, as a result of the foregoing, for the three months ended March 31, 2005 and 2006, we recorded additional interest expense of $1,533 and $127, respectively, resulting from interest rate swap payments. These interest rate swap agreements were determined to be highly effective, and therefore no ineffectiveness was recorded in earnings.
In connection with certain real estate loans, we swapped $97,000 of floating rate debt to fixed rate debt. Since the time we entered into the swap agreement, interest rates have fallen. We have recorded, in
14
(4) Derivative Instruments and Hedging Activities (Continued)
the accompanying consolidated balance sheet, the estimated cost to terminate this swap (fair value of the derivative liability) of $1,504 ($1,450 recorded in accrued expenses and $54 recorded in other long-term liabilities) as of March 31, 2006. 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 through earnings. 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 additional interest income of $1,428 and $568 for the three months ended March 31, 2005 and 2006, respectively.
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. 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 $74 (which was all recorded in accrued expenses), $22 and $52, respectively, as of March 31, 2006. For the three months ended March 31, 2005 and 2006, we recorded additional interest income of $20 and interest expense of $113, respectively, resulting from interest rate swap cash payments.
(5)Acquisitions
We account for acquisitions using the purchase method of accounting, and accordingly, the results of operations for each acquisition have been included in our consolidated results from their respective acquisition dates. Cash consideration for the various 2006 acquisitions was provided through borrowings under our credit facilities.
A summary of the consideration paid and the allocation of the purchase price of all 2006 acquisitions is as follows:
Cash Paid (Gross of cash acquired)(1)
16,476
Fair Value of Identifiable Net Assets Acquired:
Fair Value of Identifiable Assets Acquired(2)
(11,472
Liabilities Assumed(3)
6,280
Minority Interest(4)
(1,436
Total Fair Value of Identifiable Net Assets Acquired
(6,628
Recorded Goodwill
9,848
(1) Included in cash paid for acquisitions in the consolidated statements of cash flows for the three months ended March 31, 2006 are contingent payments totaling $7,032 related to acquisitions made in prior years.
(2) Consisted primarily of accounts receivable, prepaid expenses and other, land, buildings, racking and leasehold improvements. Additionally, includes customer relationship assets of $4,313 for the three months ended March 31, 2006.
(3) Consisted primarily of accounts payable, accrued expenses and notes payable.
(4) Consisted primarily of the carrying value of minority interests of European partners at the date of acquisition.
15
(5) Acquisitions(Continued)
Allocation of the purchase price for the 2006 acquisitions was based on estimates of the fair value of net assets acquired, and is subject to adjustment. The purchase price allocations of certain 2005 and 2006 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, deferred revenue 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 each 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 costs of these restructuring activities were recorded as costs of the acquisitions and were provided in accordance with EITF 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 March 31, 2006 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, 2005
Three MonthsEndedMarch 31, 2006
Reserves, Beginning Balance
21,414
12,698
Reserves Established
1,142
280
Expenditures
(7,360
(1,690
Adjustments to Goodwill, including currency effect(1)
(2,498
(69
Reserves, Ending Balance
11,219
(1) Includes adjustments to goodwill as a result of finalizing our restructuring plans.
At March 31, 2006, the restructuring reserves related to acquisitions consisted of lease losses on abandoned facilities ($8,592), severance costs for 22 people ($507), and move and other exit costs ($2,120). These accruals are expected to be used prior to March 31, 2007 except for lease losses ($6,712) and severance contracts ($152), both of which are based on contracts that extend beyond one year.
16
(6)Long-term Debt
Long-term debt consists of the following:
December 31, 2005
March 31, 2006
CarryingAmount
FairValue
IMI Revolving Credit Facility(1)
216,396
241,693
IMI Term Loan Facility(1)
345,500
344,625
IME Revolving Credit Facility(1)
84,262
84,431
IME Term Loan Facility(1)
177,450
176,750
81¤4% Senior Subordinated Notes due 2011(2)
149,760
151,500
149,771
151,875
85¤8% Senior Subordinated Notes due 2013(2)
481,032
502,513
481,027
501,311
71¤4% GBP Senior Subordinated Notes due 2014(2)
258,120
250,376
260,970
255,751
73¤4% Senior Subordinated Notes due 2015(2)
439,506
435,568
439,278
65¤8% Senior Subordinated Notes due 2016(2)
315,059
299,200
315,182
300,800
Real Estate Mortgages(1)
4,707
4,537
Seller Notes(1)
9,398
8,736
Other(1)
48,241
57,485
Total Long-term Debt
2,529,431
2,564,485
Less Current Portion
(25,905
(33,218
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, 2005 and March 31, 2006) or it is impracticable to estimate the fair value due to the nature of such long-term debt.
(2) The fair value of these debt instruments is based on quoted market prices for these notes on December 31, 2005 and March 31, 2006.
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. The interest rate on borrowings under the IME Credit Agreement varies depending on IME’s choice of currency options and interest rate period, plus an applicable margin. The IME Credit Agreement includes various financial covenants applicable to the results of IME, which may restrict IME’s ability to incur indebtedness under the IME Credit Agreement and from third parties, as well as limit IME’s ability to pay dividends to us. Most of IME’s non-dormant subsidiaries have either guaranteed the obligations or have their shares pledged to secure IME’s obligations under the IME Credit Agreement. We have not guaranteed or otherwise provided security for the IME Credit Agreement nor have any of our U.S., Canadian, Asia Pacific, Mexican or South American subsidiaries. Our consolidated balance sheet as of March 31, 2006 included 100,000 British pounds sterling and 69,807 Euro of borrowings (totaling $261,181) under the IME
17
(6) Long-term Debt (Continued)
Credit Agreement; we also had various outstanding letters of credit totaling 3,923 British pounds sterling ($6,934). The remaining availability, based on its current level of external debt and the leverage ratio under the IME revolving credit facility on January 31, 2006, was approximately 48,587 British pounds sterling ($85,878). The interest rates in effect under the IME revolving credit facility ranged from 3.6% to 5.9% as of January 31, 2006. For the three months ended March 31, 2005 and 2006, we recorded commitment fees of $206 and $137, respectively, based on 0.9% and 0.6% 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 had an aggregate principal amount of $550,000 and was comprised of a $350,000 revolving credit facility (the “IMI revolving credit facility”), which included 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%. On October 31, 2005, we entered into the second amendment to the IMI Credit Agreement, increasing availability under the revolving credit facility from $350,000 to $400,000. As a result, the IMI Credit Agreement had an aggregate maximum principal amount of $750,000 as of December 31, 2005. 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 March 31, 2006, we had $241,693 of borrowings under our IMI revolving credit facility, of which $33,500 was denominated in U.S. dollars and the remaining balance was denominated in Canadian dollars (CAD 183,000), in Australian dollars (AUD 55,000) and in New Zealand dollars (NZD 20,200); we also had various outstanding letters of credit totaling $23,827. The remaining availability, based on IMI’s current level of external debt and the leverage ratio under the IMI revolving credit facility, on March 31, 2006 was $134,480. The interest rate in effect under the IMI revolving credit facility and IMI term loan facility was 6.1% and 6.9%, respectively, as of March 31, 2006. For the three months ended March 31, 2005 and 2006, we recorded commitment fees of $257 and $126, 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, IMI Credit Agreement and our indentures and other agreements governing our indebtedness. We were in compliance with all material debt covenants as of March 31, 2006.
18
(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, 2005 and March 31, 2006 and for the three months ended March 31, 2005 and 2006. The Guarantors column includes all subsidiaries that guarantee the senior subordinated notes. 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
Consolidated
Assets
Cash and Cash Equivalents
10,658
42,755
Accounts Receivable
290,546
118,018
Intercompany Receivable
868,392
(868,392
Other Current Assets
48
61,531
31,074
(462
92,191
868,440
362,735
191,847
(868,854
Property, Plant and Equipment, Net
1,225,580
555,686
Other Assets, Net:
Long-term Notes Receivable from Affiliates and Intercompany Receivable
2,048,104
11,069
(2,059,173
Investment in Subsidiaries
541,612
252,122
(793,734
1,482,537
646,363
9,741
26,780
130,012
135,694
(421
292,065
Total Other Assets, Net
2,616,496
1,875,740
782,057
(2,843,587
3,484,936
3,464,055
1,529,590
(3,712,441
Liabilities and Stockholders’ Equity
Intercompany Payable
249,173
619,219
Current Portion of Long-term Debt
3,841
7,613
14,451
Total Other Current Liabilities
48,229
389,691
128,633
566,091
2,057,884
10,816
434,826
Long-term Notes Payable to Affiliates and Intercompany Payable
1,000
10,069
3,853
233,805
57,385
294,622
Commitments and Contingencies
2,389
3,478
Stockholders’ Equity
524,853
262,618
(787,471
19
(7) Selected Financial Information of Parent, Guarantors and Non-Guarantors(Continued)
14,615
27,937
287,107
134,829
868,382
(868,382
65,714
33,300
(457
98,605
868,430
367,436
196,066
(868,839
1,228,951
577,842
2,085,448
11,084
(2,096,532
550,012
259,323
(809,335
1,485,770
635,861
25,909
130,187
140,698
(695
296,099
2,661,369
1,886,364
776,559
(2,896,821
3,529,799
3,482,751
1,550,467
(3,765,660
262,789
605,593
4,093
7,210
21,915
46,194
334,304
137,278
517,319
2,072,610
11,900
446,757
10,084
247,614
58,060
308,832
(238
4,910
533,486
271,018
(804,504
20
(7) Selected Financial Information of Parent, Guarantors and Non-Guarantors (Continued)
Three Months Ended March 31, 2005
208,053
77,302
Service and Storage Material Sales
153,034
63,017
361,087
140,319
Cost of Sales (Excluding Depreciation)
161,405
69,223
Selling, General and Administrative
54
100,309
34,977
Depreciation and Amortization
32,276
12,261
Gain on Disposal/Writedown of Property, Plant and Equipment, Net
(203
63
293,787
116,446
Operating (Loss) Income
(63
67,300
23,873
Interest Expense (Income), Net
39,089
(8,253
14,970
Equity in the Earnings of Subsidiaries, Net of Tax
(54,818
(4,525
59,343
Other (Income) Expense, Net
(7,283
10,933
1,013
69,145
7,890
(59,343
14,691
2,545
54,454
4,889
21
Three Months Ended March 31, 2006
232,248
86,907
169,618
74,884
401,866
161,791
180,228
82,140
(152
121,100
37,895
35,311
14,517
(Gain) Loss on Disposal/Writedown of Property, Plant and Equipment, Net
(33
196
(132
336,606
134,748
132
65,260
27,043
40,533
(9,402
15,447
(68,382
(8,342
76,724
708
(1,257
(2,298
84,261
13,894
(76,724
16,547
4,424
67,714
9,010
22
(39,927
93,046
10,295
(39,735
(18,911
(13,958
(19,255
Intercompany loans to subsidiaries
54,561
19,652
(74,213
Investment in subsidiaries
(15,686
31,372
(1,641
(1,242
38,875
(51,097
(39,408
(42,841
(104,318
(797
(10,308
100,000
39,253
Intercompany loans from parent
(55,216
(18,997
74,213
Equity contribution from parent
15,686
(31,372
(16
(42
1,052
(40,327
23,888
42,841
Increase (Decrease) in cash and cash equivalents
1,622
(4,788
Cash and cash equivalents, beginning of period
11,021
20,921
Cash and cash equivalents, end of period
12,643
16,133
23
(38,834
86,120
14,712
(54,209
(19,468
(9,546
(13,821
22,297
11,329
(33,626
(2,288
(690
(608
(137
(55,322
(37,214
(167,389
(3,413
(6,643
181,773
25,979
(23,428
(10,198
33,626
16,537
(26,841
7,868
3,957
(14,818
24
(8) Segment Information
Beginning January 1, 2006, we changed our reportable segments as a result of certain management and organizational changes within our North American business. Therefore, the presentation of all historical segment reporting has been changed to conform to our new management reporting. Our previous Business Records Management, Data Protection and Fulfillment operating segments are now considered one operating segment which we refer to as the “North American Physical Business”. Online backup and recovery solutions for remote server data and intellectual property management services are now included in the Worldwide Digital Business segment and were previously included in our old Data Protection segment. We now have six operating segments, as follows:
· North American Physical Business—throughout the United States and Canada, the storage of paper documents, as well as all other non-electronic media such as microfilm and microfiche, master audio and videotapes, film, X-rays and blueprints, including healthcare information services, vital records services, service and courier operations, and the collection, handling and disposal of sensitive documents for corporate customers (“Hard Copy”); the storage and rotation of backup computer media as part of corporate disaster recovery plans, including service and courier operations (“Data Protection”); secure shredding services (“Shredding”); and the storage, assembly, and detailed reporting of customer marketing literature and delivery to sales offices, trade shows and prospective customers’ sites based on current and prospective customer orders, which we refer to as the “Fulfillment” business
· Worldwide Digital Business—storage and related archiving services for electronic records conveyed via telecommunication lines and the Internet, including online backup and recovery solutions for remote server data and personal computers, as well as email archiving and third party technology escrow services that protect intellectual property assets such as software source code
· Europe—information protection and storage services throughout Europe, including Hard Copy, Data Protection and Shredding
· South America—information protection and storage services throughout South America, including Hard Copy and Data Protection
· Mexico—information protection and storage services throughout Mexico, including Hard Copy and Data Protection
· Asia Pacific—information protection and storage services throughout Australia and New Zealand, including Hard Copy, Data Protection and Shredding
The South America, Mexico and Asia Pacific operating segments do not individually meet the quantitative thresholds for a reportable segment, but have been aggregated and reported with Europe as one reportable segment, “International Physical Business,” given their similar economic characteristics, products, customers and processes. The Worldwide Digital Business does not meet the quantitative criteria for a reportable segment; however, management determined that it would disclose such information on a voluntary basis.
25
(8) Segment Information (Continued)
An analysis of our business segment information and reconciliation to the consolidated financial statements is as follows:
370,920
107,458
23,028
28,590
10,134
5,822
Contribution
110,742
25,090
(394
135,438
3,242,248
1,067,675
198,007
4,507,930
Expenditures for Segment Assets(1)
56,551
35,058
3,133
94,742
409,901
122,971
30,785
30,528
12,351
6,969
113,984
29,108
(646
142,446
3,403,131
1,160,453
233,773
66,546
29,221
4,255
100,022
(1) 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 except that certain corporate and centrally controlled costs are allocated primarily to our North American Physical Business and Worldwide Digital Business segments. These allocations, which include human resources, information technology, finance, rent, real estate property taxes, medical costs, incentive compensation, stock option expense, worker’s compensation, 401(k) match contributions and property, general liability, auto and other insurance, are based on rates and methodologies established at the beginning of each year. Included in the corporate costs allocated to our North American Physical Business segment are certain costs related to staff functions, including finance, human resources and information technology, which benefit the enterprise as a whole. These costs are primarily related to the general management of these functions on a corporate level and the design and development of programs, policies and procedures that are then implemented in the individual segments, with each segment bearing its own cost of implementation. Management has decided to allocate these costs to the North American segment as further allocation is impracticable.
Previously, certain corporate and centrally controlled costs were either not allocated or variances associated with the allocated charges and the actual charges were not pushed down to the operating segments, and these costs and variances remained in our previously reported segment named Corporate and Other. This is no longer the case, and all previously reported periods have been updated to reflect the new methodologies being employed.
26
Contribution for each segment is defined as 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 income before provision for income taxes and minority interest on a consolidated basis is as follows:
Less: Depreciation and Amortization
Income before Provision for Income Taxes and Minority Interest
(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, 2005. See our Annual Report on Form 10-K for the year ended December 31, 2005 for amounts outstanding at December 31, 2005.
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 are pending to which we, or any of our properties, are subject. We record legal costs associated with loss contingencies as expenses in the period in which they are incurred.
27
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 months ended March 31, 2006 should be read in conjunction with our consolidated financial statements and notes thereto for the three months ended March 31, 2006, included herein, and for the year ended December 31, 2005, included in our Annual Report on Form 10-K for the year ended December 31, 2005.
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) the cost to comply with current and future legislation or regulation relating to privacy issues; (5) the impact of litigation that may arise in connection with incidents of inadvertent disclosures of customers’ confidential information; (6) our ability or inability to complete acquisitions on satisfactory terms and to integrate acquired companies efficiently; (7) the cost and availability of financing for contemplated growth; (8) business partners upon whom we depend for technical assistance or management and acquisition expertise outside the U.S. will not perform as anticipated; (9) changes in the political and economic environments in the countries in which our international subsidiaries operate; and (10) other trends in competitive or economic conditions affecting our financial condition or results of operations not presently contemplated. You should not rely upon forward-looking statements except as statements of our present intentions and of our present expectations, which may or may not occur. Other risks may adversely impact us, as described more fully under “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2005. 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, (2) other (income) expense, net, (3) income from discontinued operations and loss on sale of discontinued operations and (4) cumulative effect of change in accounting principle 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 evaluates 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 accounting principles generally accepted in the Unites States of America, or 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
135,656
142,283
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 accounting principles generally accepted in the United States of America. 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 accounting for acquisitions, allowance for doubtful accounts and credit memos, impairment of tangible and intangible assets, income taxes, stock-based compensation and self-insured liabilities. We base our estimates on historical experience, actuarial estimates, current conditions and various other assumptions that we believe to be reasonable under the circumstances. These estimates form the basis for making judgments about the carrying values of assets and liabilities and are not readily apparent from other sources. Actual results may differ from these estimates. Our critical accounting policies include the following, which are listed in no particular order:
· Accounting for Acquisitions
· Allowance for Doubtful Accounts and Credit Memos
· Impairment of Tangible and Intangible Assets
· Accounting for Internal Use Software
29
· Income Taxes
· Stock-Based Compensation
· 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, 2005 as filed with the SEC. Management has determined that no material changes concerning our critical accounting policies have occurred since December 31, 2005.
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 month period ended March 31, 2006 within each section.
Results of Operations
Comparison of Three Months Ended March 31, 2006 to Three Months Ended March 31, 2005 (in thousands):
DollarChange
PercentChange
Revenues
62,251
12.4
%
Operating Expenses
60,926
14.8
1,325
1.5
Other Expenses, Net
68,161
65,162
(2,999
(4.4
)%
4,324
18.8
OIBDA(1)
6,627
4.9
OIBDA Margin(1)
27.1
25.2
(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.
REVENUES
Our consolidated storage revenues increased $33.8 million, or 11.8%, to $319.2 million for the three months ended March 31, 2006 from $285.4 million for the three months ended March 31, 2005. The increase is attributable to internal revenue growth (10%), resulting from net increases in records and other media stored by existing customers, sales to new customers, the net result of pricing actions, and acquisitions (3%), net of a decrease due to foreign currency exchange rate fluctuations (1%).
Consolidated service and storage material sales revenues increased $28.5 million, or 13.2%, to $244.5 million for the three months ended March 31, 2006 from $216.1 million for the three months ended March 31, 2005. The increase is attributable to internal revenue growth (8%) resulting from net increases in service and storage material sales to existing customers, sales to new customers, and acquisitions (6%), net of a decrease due to foreign currency exchange rate fluctuations (1%).
For the reasons stated above, our consolidated revenues increased $62.3 million, or 12.4%, to $563.7 million for the three months ended March 31, 2006 from $501.4 million for the three months ended March 31, 2005. Foreign currency exchange rate fluctuations that impacted our revenues were primarily
30
due to the weakening of the British pound sterling and Euro, net of the strengthening of the Canadian dollar, against the U.S. dollar, based on an analysis of weighted average rates for the comparable periods. Internal revenue growth was 6%, and 10% for the three months ended March 31, 2005, and 2006, respectively. We calculate internal revenue growth in local currency for our international operations.
Internal Growth—Eight-Quarter Trend
2004
SecondQuarter
ThirdQuarter
FourthQuarter
FirstQuarter
Storage Revenue
Service and Storage Material Sales Revenue
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 increased from a range of 8% to 9% to a range of 9% to 10%. In our North American physical business, net carton volume growth remained stable and we benefited from a more positive pricing environment in 2005 and 2006 compared to 2004. Strong growth rates in our digital services business more than offset the impact of reduced growth rates in Europe resulting from the inclusion of the slower growing Hays plc business in our base revenues for internal growth calculation purposes effective in the first quarter of 2005. 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 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 for service and storage material sales revenues has been stronger over the past several quarters. The internal growth rate for service and storage material sales revenues reflects the following: (1) stronger data product sales, particularly in 2005 compared to 2004; (2) a large data restoration project completed by our digital services business in the third quarter of 2005; (3) growth in North American storage related service revenues; (4) continued growth in our secure shredding operations; and (5) improved growth rates in our data protection business. These positive factors were partially offset by lower special project revenues related to the public sector business in the U.K., particularly in 2005 compared to 2004.
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OPERATING EXPENSES
Cost of Sales
Consolidated cost of sales (excluding depreciation) is comprised of the following expenses (in thousands):
Dollar
Percent
% of ConsolidatedRevenues
PercentChange(Favorable)/
Change
Unfavorable
Labor
110,261
125,707
15,446
14.0
22.0
22.3
0.3
Facilities
70,750
80,436
9,686
13.7
14.1
14.3
0.2
Transportation
22,696
26,528
3,832
16.9
4.5
4.7
Product Cost of Sales
11,977
13,013
1,036
8.6
2.4
2.3
(0.1
14,944
16,684
1,740
11.6
3.0
31,740
13.8
46.0
46.5
0.5
For the three months ended March 31, 2006 as compared to the three months ended March 31, 2005, labor expense increased as a percentage of consolidated revenues mainly as a result of higher labor costs in our Australia/New Zealand acquisition driven by their ongoing real estate rationalization program and our recent acquisitions in Europe which have a higher service revenue component and are therefore more labor intensive. Our digital business had higher costs of labor associated with internal information technology personnel and consultants dedicated to revenue producing projects.
Facilities costs as a percentage of consolidated revenues increased to 14.3% as of March 31, 2006 from 14.1% as of March 31, 2005. The increase in facilities costs as a percentage of consolidated revenues was primarily a result of increases in utilities and maintenance costs. Rent expense decreased slightly as a percentage of consolidated revenues for the three months ended March 31, 2006 compared to the three months ended March 31, 2005 as a result of maintaining approximately the same overall base rent per square foot in our North American operations in 2005 and 2006 while consolidated revenues increased. The largest component of our facilities cost is rent expense, which increased $4.1 million for the three months ended March 31, 2006 compared to the three months ended March 31, 2005. The expansion of our secure shredding operations, which incurs lower facilities costs than our core physical businesses, also helped lower our facilities costs as a percentage of consolidated revenues.
Our transportation expenses, which increased 0.2% as a percentage of consolidated revenues for the three months ended March 31, 2006 compared to the three months ended March 31, 2005, are influenced by several variables including total number of vehicles, owned versus leased vehicles, use of subcontracted couriers, fuel expenses and maintenance. Higher fuel and rental costs associated with leased vehicles, mainly attributable to the migration from owned to leased vehicles compounded by a shift in the mix of vehicles from light vans to larger more expensive trucks, during the three months ended March 31, 2006 compared to the three months ended March 31, 2005, 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. Total product and other cost of sales for the three months ended March 31, 2006 were slightly lower compared
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to the three months ended March 31, 2005 primarily as a result of improved vendor procurement pricing related to product sales.
Selling, General and Administrative Expenses
Selling, general and administrative expenses are comprised of the following expenses (in thousands):
General and Administrative
68,081
79,130
11,049
16.2
13.6
0.4
Sales, Marketing & Account Management
42,645
51,593
8,948
21.0
8.5
9.2
0.7
Information Technology
23,834
27,721
3,887
16.3
4.8
0.1
Bad Debt Expense
780
399
(381
(48.8
23,503
17.4
27.0
28.2
1.2
The increase in general and administrative expenses as a percentage of consolidated revenues for the three months ended March 31, 2006 compared to the three months ended March 31, 2005 is mainly attributable to increased compensation expense in our North American operations due to expansion through acquisitions, primarily LiveVault Corporation (“LiveVault”), as well as, costs associated with our North American reorganization which added a new level of field management, as well as costs associated with a North American field operations meeting held in the first quarter of 2006 that was not held in the first quarter of 2005.
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, marketing and account management expenses as a percentage of consolidated revenues for the three months ended March 31, 2006. Throughout 2005 and into 2006, we invested in the expansion and improvement of our sales, marketing and account management functions. We have added sales and marketing employees and enlarged our account management team by hiring more experienced personnel at a higher cost. The costs associated with these efforts have contributed to the increase in our sales, marketing and account management expenses. Additionally, costs associated with an enterprise-wide sales meeting held in the first quarter of 2006 and not in the first quarter of 2005 also contributed to this increase. Our larger North American sales force generated a $2.9 million increase in sales commissions and an increase of $3.5 million of compensation expense for the quarter ended March 31, 2006 compared to the quarter ended March 31, 2005.
Information technology expenses increased as a percentage of consolidated revenues for the three months ended March 31, 2006 compared to the three months ended March 31, 2005 due to increases in technology development activities within our digital services business, including the acquisition of LiveVault and associated research and development activities. Higher utilization of existing information technology resources to revenue producing projects, which are charged to costs of goods sold and decreased information technology spending in our European operations, partially offset this increase.
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Consolidated depreciation and amortization expense increased $5.3 million to $49.8 million (8.8% of consolidated revenues) for the three months ended March 31, 2006 from $44.5 million (8.9% of consolidated revenues) for the three months ended March 31, 2005. Depreciation expense increased $4.8 million for the three months ended March 31, 2006 compared to the three months ended March 31, 2005 primarily due to the additional depreciation expense related to recent capital expenditures, capital leases and acquisitions, including storage systems, which include racking, building and leasehold improvements, computer systems hardware and software, and buildings. Amortization expense increased $0.5 million for the three months ended March 31, 2006 compared to the three months ended March 31, 2005 due to amortization of intangible assets, such as customer relationship intangible assets and intellectual property acquired through business combinations. We expect that amortization expense will continue to increase as we acquire new businesses and reflect the full year impact of our acquisitions of LiveVault, Pickfords Records Management (“Pickfords”) and our other 2005 acquisitions, most of which were completed in the second half of the year.
OPERATING INCOME
As a result of the foregoing factors, consolidated operating income increased $1.3 million, or 1.5%, to $92.4 million (16.4% of consolidated revenues) for the three months ended March 31, 2006 from $91.1 million (18.2% of consolidated revenues) for the three months ended March 31, 2005.
As a result of the foregoing factors, consolidated OIBDA increased $6.6 million, or 4.9%, to $142.3 million (25.2% of consolidated revenues) for the three months ended March 31, 2006 from $135.7 million (27.1% of consolidated revenues) for the three months ended March 31, 2005.
OTHER EXPENSES, NET
Consolidated interest expense, net increased $0.7 million to $46.6 million (8.3% of consolidated revenues) for the three months ended March 31, 2006 from $45.8 million (9.1% of consolidated revenues) for the three months ended March 31, 2005 primarily due to increased borrowings to fund our 2005 and 2006 acquisitions, particularly LiveVault and Pickfords, offset by a decrease in our weighted average interest rate to 7.3% as of March 31, 2006 from 7.6% as of March 31, 2005.
Other Expense (Income), Net (in thousands)
Three MonthsEndedMarch 31,
Foreign currency transaction (gains) losses
4,789
(1,329
(6,118
(126
(1,518
(1,392
(7,510
Foreign currency gains of $1.3 million based on period-end exchange rates were recorded in the three months ended March 31, 2006, primarily due to the strengthening of the British pound sterling and Euro, and the weakening of the Australian dollar against the U.S. dollar compared to December 31, 2005 as these currencies relate to our intercompany balances with and between our Australian, U.K., and
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European subsidiaries, borrowings denominated in foreign currencies under our revolving credit facility and British pounds sterling denominated debt held by our U.S. parent company.
Foreign currency losses of $4.8 million based on period-end exchange rates were recorded in the three months ended March 31, 2005, primarily due to the weakening of the British pound sterling, Canadian dollar, and Euro against the U.S. dollar compared to December 31, 2004 as these currencies relate to our intercompany balances with and between our Canadian, U.K., and European subsidiaries and British pounds sterling denominated debt held by our U.S. parent company.
Our effective tax rates for the three months ended March 31, 2005 and 2006 were 42.4%, and 43.1%, 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. We are subject to examination by various tax authorities in jurisdictions in which we have significant business operations. We regularly assess the likelihood of additional assessments by tax authorities and provide for these matters as appropriate. Although we believe our tax estimates are appropriate, the final determination of tax audits and any related litigation could result in changes in our estimates.
Minority interest in earnings of subsidiaries, net resulted in a charge to income of $0.5 million (0.1% of consolidated revenues) for both the three months ended March 31, 2005 and 2006. 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, for the three months ended March 31, 2006 consolidated net income was $27.3 million (4.8% of consolidated revenues) compared to consolidated net income of $22.9 million (4.6% of consolidated revenues) for the three months ended March 31, 2005.
Segment Analysis (in thousands)
The results of our various operating segments are discussed below. Beginning January 1, 2006, we changed our reportable segments as a result of certain management and organizational changes within our North American business. Therefore, the presentation of all historical segment reporting has been changed to conform to our new management reporting. Our reportable segments are now North American Physical Business, International Physical Business and Worldwide Digital Business. See Note 8 of Notes to Consolidated Financial Statements. Our North American Physical Business, which consists of the United States and Canada, offers the storage of paper documents, as well as all other non-electronic media such as microfilm and microfiche, master audio and videotapes, film, X-rays and blueprints, including healthcare information services, vital records services, service and courier operations, and the collection, handling and disposal of sensitive documents for corporate customers (“Hard Copy”); the storage and rotation of backup computer media as part of corporate disaster recovery plans, including service and courier operations (“Data Protection”); secure shredding services (“Shredding”); and the storage, assembly, and detailed reporting of customer marketing literature and delivery to sales offices, trade shows and prospective customers’ sites based on current and prospective customer orders, which we refer to as the “Fulfillment” business. Our International Physical Business segment offers information and protection services throughout Europe, South America, Mexico and Asia Pacific, including Hard Copy, Data Protection and Shredding. Our Worldwide Digital Business offers storage and related archiving services
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for electronic records conveyed via telecommunication lines and the Internet, including online backup and recovery solutions for remote server data and personal computers, as well as email archiving and third party technology escrow services that protect intellectual property assets such as software source code.
North American Physical Business
Segment Revenue
Segment Contribution(1)
Segment Contributionas a Percentageof Segment Revenue
March 31,2005
March 31,2006
Increase inRevenues
PercentageIncrease inRevenues
Three Months Ended
38,981
10.5
29.9
27.8
Items Excluded from the Calculation of Contribution(1)
March 31, 2005
(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 income before provision for income taxes and minority interest on a consolidated basis.
During the three months ended March 31, 2006, revenue in our North American Physical Business segment increased 10.5% primarily due to increasing storage internal growth rates resulting from stable net volume growth and a positive pricing environment, increasing service revenue growth rates particularly in data protection, growth of our secure shredding operations, and acquisitions. In addition, favorable currency fluctuations during the three months ending March 31, 2006 in Canada increased revenue, as measured in U.S. dollars, by $2.2 million when compared to the three months ending March 31, 2005. Contribution as a percent of segment revenue decreased in the three months ended March 31, 2006 due mainly to (a) higher transportation costs, primarily fuel and rental costs associated with leased vehicles, mainly attributable to the migration from owned to leased vehicles compounded by a shift in the mix of vehicles from light vans to larger more expensive trucks, (b) increased facility costs, primarily utilities and maintenance, (c) increased investment in sales, marketing and account management primarily related to a shift in hiring more experienced personnel at a higher cost, (d) costs associated with the North American reorganization, including a new level of field management, (e) costs associated with our enterprise-wide sales meeting and a field operations meeting, both held in the first quarter of 2006 but not in the first quarter of 2005 and (f) higher labor costs associated with recent acquisitions.
Included in our North American Physical Business segment are certain costs related to staff functions, including finance, human resources and information technology, which benefit the enterprise as a whole. These costs are primarily related to the general management of these functions on a corporate level and the design and development of programs, policies and procedures that are then implemented in the individual segments, with each segment bearing its own cost of implementation. Management has decided to allocate these costs to the North American segment as further allocation is impracticable.
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International Physical Business
Segment Contributionas a Percentage ofSegment Revenue
15,513
14.4
23.3
23.6
Revenue in our International Physical Business segment increased 14.4% during the three months ended March 31, 2006 primarily due to the acquisition of Pickfords in December 2005, which contributed $9.7 million in revenue during the first three months of 2006, and strong internal growth in Latin America. This was partially offset by net unfavorable currency fluctuations during the three months ended March 31, 2006 primarily in Europe that decreased revenue, as measured in U.S. dollars, by $7.7 million compared to the three months ended March 31, 2005. Contribution as a percent of segment revenue increased primarily due to strong revenue growth augmented by a delay in recruitment of new sales and marketing personnel, and a decrease in bad debt expense.
Worldwide Digital Business
Segment Contribution as a Percentage of Segment Revenue
7,757
33.7
(1.7
(2.1
During the three months ended March 31, 2006, revenue in our Worldwide Digital Business segment increased 33.7% primarily due to strong internal growth of 27%, attributable to our online backup service offerings for both personal computer and server data and increased storage of archived data, and the acquisition of LiveVault, which contributed $2.2 million in revenue during the first three months of 2006. Contribution as a percent of segment revenue decreased primarily due to the acquisition of LiveVault,
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increased investment in the European sales force and increases in information technology costs offset by a reduction in royalty payments.
Liquidity and Capital Resources
The following is a summary of our cash balances and cash flows for the three months ended March 31, 2005 and 2006 (in thousands):
Cash flows provided by operating activities
Cash flows used in investing activities
Cash flows provided by financing activities
Cash and cash equivalents at the end of period
Net cash provided by operating activities was $62.0 million for the three months ended March 31, 2006 compared to $63.4 million for the three months ended March 31, 2005. The decrease resulted primarily from an increase in operating income and non-cash items, such as depreciation offset by the net change in assets and liabilities. The net change in assets and liabilities is primarily associated with higher incentive compensation payments, a decrease in accounts payable and improved receivables collections.
Due to the nature of our businesses, we make significant capital expenditures and additions to customer relationship and acquisition costs. 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 capital expenditures and additions to customer relationship and acquisition costs during the three months ended March 31, 2006 amounted to $76.7 million. For the three months ended March 31, 2006, capital expenditures, net and additions to customer relationship and acquisition costs were funded primarily with cash flows provided by operating activities, augmented with borrowings under our revolving credit facility and cash and cash equivalents on-hand. Excluding acquisitions, we expect our capital expenditures to be between $320 million and $360 million in the year ending December 31, 2006. Included in our estimated capital expenditures for 2006 is $50 million to $60 million of opportunity driven real estate purchases.
In the three months ended March 31, 2006, we paid net cash consideration of $23.4 million for acquisitions, primarily related to the acquisition of Secure Destruction Limited in the U.K., the buyout of a minority partner in France and a contingent payment associated with a shredding acquisition in the U.S. Borrowings under our revolving credit facilities funded these acquisitions.
Net cash provided by financing activities was $31.2 million for the three months ended March 31, 2006. During the three months ended March 31, 2006, we had gross borrowings under our revolving credit facilities and term loan facilities of $207.8 million and $2.2 million of proceeds from the exercise of stock options. We used the proceeds from these financing transactions to repay debt and term loans ($177.4 million), repay debt financing from minority stockholders, net ($1.3 million) and to fund acquisitions.
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We are highly leveraged and expect to continue to be highly leveraged for the foreseeable future. Our consolidated debt as of March 31, 2006 was comprised of the following (in thousands):
IMI Revolving Credit Facility (1)
IME Revolving Credit Facility
IME Term Loan Facility
81¤4% Senior Subordinated Notes due 2013(2)
Real Estate Mortgages
Seller Notes
(1) All intercompany notes and the capital stock of most of our U.S. subsidiaries are pledged to secure these debt instruments.
(2) 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 the senior subordinated notes.
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 as of December 31, 2005 and March 31, 2006. 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 March 31, 2006 includes 100.0 million British pounds sterling and 69.8 million Euro of borrowing (totaling $261.2 million) under the IME Credit Agreement; we also had various outstanding letters of credit totaling 3.9 million British pounds sterling ($6.9 million). The remaining availability, based on its current level of external debt and the leverage ratio under the IME revolving credit facility on January 31, 2006, was approximately 48.6 million British pounds sterling ($85.9 million). The interest rates in effect under the IME revolving credit facility ranged from 3.6% to 5.9% as of January 31, 2006.
As of March 31, 2006, we had $241.7 million of borrowings under the IMI revolving credit facility, of which $33.5 was denominated in U.S. dollars and the remaining balance was denominated in Canadian dollars (CAD 183.0 million), in Australian dollars (AUD 55.0 million), and in New Zealand dollars (NZD 20.2 million); we also had various outstanding letters of credit totaling $23.8 million. The remaining
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availability, based on Iron Mountain Incorporated’s current level of external debt and the leverage ratio under the IMI revolving credit facility, on March 31, 2006 was $134.5 million. The interest rate in effect under the IMI revolving credit facility and IMI tern loan facility was 6.1% and 6.9%, respectively, as of March 31, 2006.
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 and IME revolving credit facilities and other financings, which may include secured credit facilities, securitizations and mortgage or capital lease financings. We expect to meet our long-term cash flow requirements using the same means described above, as well as the potential issuance of debt or equity securities as we deem appropriate. See Note 6 to Notes to Consolidated Financial Statements.
Net Operating Loss Carryforwards
At March 31, 2006, we had estimated net operating loss carryforwards of approximately $109 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. As a result of these loss carryforwards, we do not expect to pay any significant U.S. federal and state income taxes in 2006.
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 May 2001 and April 2004 we and IME entered into a total of three derivative financial contracts, which are variable-for-fixed interest rate swaps consisting of one contract for interest payments payable on the IMI term loan facility of an
aggregate principal amount of $99.5 million that was reduced to an aggregate principal amount of $51.5 million as of December 31, 2005 and 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.
After consideration of the swap contracts mentioned above, as of March 31, 2006, we had $593.5 million of variable rate debt outstanding with a weighted average variable interest rate of 6.0%, and $1,971.0 million of fixed rate debt outstanding. As of March 31, 2006, 77% 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 quarter ended March 31, 2006 would have been reduced by $0.9 million. 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 March 31, 2006.
Currency Risk
Our investments in IME, Iron Mountain Canada Corporation (“IM Canada”), Iron Mountain Mexico, SA de RL de CV, IMSA 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 Euro, Canadian dollar and British pound sterling. 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 and our foreign subsidiaries and IME. 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 a natural 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 three foreign investments in the U.K., Canada and Asia Pacific. Specifically, through IME borrowing under the IME Credit Agreement and our 150 million British pounds sterling denominated 71¤4% senior subordinated notes, we effectively hedge most of our outstanding intercompany loan with IME. IM Canada has financed their capital needs through direct borrowings in Canadian dollars under the IMI revolving credit facility. This creates a tax efficient natural currency hedge. To fund the acquisition of Pickfords in Australia and New Zealand, IMI borrowed Australian and New Zealand dollars under its multi-currency revolving credit facility. These borrowings provide a tax efficient natural hedge against the intercompany loans created at the time of the acquisition. As of March 31, 2006, except as noted above, our currency exposures to intercompany balances are unhedged.
The impact of devaluation or depreciating currency on an entity depends on the residual effect on the local economy and the ability of an entity to raise prices and/or reduce expenses. Due to our constantly changing currency exposure and the potential substantial volatility of currency exchange rates, we cannot predict the effect of exchange fluctuations on our business. The effect of a change in foreign exchange
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rates on our net investment in foreign subsidiaries is reflected in the “Accumulated Other Comprehensive Items” component of stockholders’ equity.
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 March 31, 2006 (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 March 31, 2006 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
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 are pending to which we, or any of our properties, are subject.
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 March 31, 2006:
Issuer Purchases of Equity Securities
Period
Total Numberof SharesPurchased(1)
Average PricePaid per Share
Total Numberof SharesPurchased as Partof PubliclyAnnounced Plansor Programs
Maximum Number(or ApproximateDollar Value) ofShares that May YetBe Purchased Underthe Plans orPrograms
February 1, 2006-February 28, 2006
881
44.39
March 1, 2006-March 31, 2006
1,450
41.37
2,331
42.51
(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
Rule 13a-14(a) Certification of Chief Executive Officer.
31.2
Rule 13a-14(a) Certification of Chief Financial Officer.
32.1
Section 1350 Certification of Chief Executive Officer.
32.2
Section 1350 Certification of Chief Financial Officer.
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.
May 10, 2006
BY:
/s/ JOHN F. KENNY, JR.
(DATE)
John F. Kenny, Jr.
Executive Vice President,
Chief Financial Officer and Director
(Principal Financial Officer)