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 June 30, 2006
Or
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period from to
Commission file number 1-13045
IRON MOUNTAIN INCORPORATED
(Exact Name of Registrant as Specified in Its Charter)
Delaware
23-2588479
(State or Other Jurisdiction of Incorporation or Organization)
(I.R.S. Employer 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 filer o 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 August 1, 2006: 132,242,111
Index
Page
PART I—FINANCIAL INFORMATION
Item 1—Unaudited Consolidated Financial Statements
Consolidated Balance Sheets at December 31, 2005 and June 30, 2006 (Unaudited)
3
Consolidated Statements of Operations for the Three Months Ended June 30, 2005 and 2006 (Unaudited)
4
Consolidated Statements of Operations for the Six Months Ended June 30, 2005 and 2006 (Unaudited)
5
Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2005 and 2006 (Unaudited)
6
Notes to Consolidated Financial Statements (Unaudited)
7
Item 2—Management’s Discussion and Analysis of Financial Condition and Results of Operations
33
Item 3—Quantitative and Qualitative Disclosures About Market Risk
48
Item 4—Controls and Procedures
49
PART II—OTHER INFORMATION
Item 1—Legal Proceedings
50
Item 1A—Risk Factors
Item 2—Unregistered Sales of Equity Securities and Use of Proceeds
Item 4—Submission of Matters to a Vote of Security-Holders
Item 6—Exhibits
52
Signature
53
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,
June 30,
2005
2006
ASSETS
Current Assets:
Cash and cash equivalents
$
53,413
40,952
Accounts receivable (less allowances of $14,522 and $14,181, respectively)
408,564
440,285
Deferred income taxes
27,623
25,745
Prepaid expenses and other
64,568
82,614
Total Current Assets
554,168
589,596
Property, Plant and Equipment:
Property, plant and equipment
2,556,880
2,746,506
Less—Accumulated depreciation
(775,614
)
(870,990
Net Property, Plant and Equipment
1,781,266
1,875,516
Other Assets, net:
Goodwill
2,138,641
2,186,367
Customer relationships and acquisition costs
229,006
243,902
Deferred financing costs
31,606
29,046
Other
31,453
32,485
Total Other Assets, net
2,430,706
2,491,800
Total Assets
4,766,140
4,956,912
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities:
Current portion of long-term debt
25,905
65,762
Accounts payable
148,234
139,564
Accrued expenses
266,720
244,203
Deferred revenue
151,137
159,685
Total Current Liabilities
591,996
609,214
Long-term Debt, net of current portion
2,503,526
2,541,996
Other Long-term Liabilities
33,545
35,150
Deferred Rent
35,763
47,366
Deferred Income Taxes
225,314
254,500
Commitments and Contingencies (see Note 9)
Minority Interests
5,867
5,083
Stockholders’ Equity:
Preferred stock (par value $0.01; authorized 10,000,000 shares; none issued and outstanding)
—
Common stock (par value $0.01; authorized 400,000,000 shares; issued and outstanding 131,662,871 shares and 132,164,748 shares, respectively)
1,317
1,322
Additional paid-in capital
1,105,604
1,123,622
Retained earnings
244,524
309,639
Accumulated other comprehensive items, net
18,684
29,020
Total Stockholders’ Equity
1,370,129
1,463,603
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 EndedJune 30,
Revenues:
Storage
291,666
327,863
Service and storage material sales
220,256
253,705
Total Revenues
511,922
581,568
Operating Expenses:
Cost of sales (excluding depreciation)
228,088
259,290
Selling, general and administrative
141,313
168,285
Depreciation and amortization
44,745
51,273
Loss (Gain) on disposal/writedown of property, plant and equipment, net
1,083
(174
Total Operating Expenses
415,229
478,674
Operating Income
96,693
102,894
Interest Expense, Net
47,222
47,254
Other Expense (Income), Net
4,946
(6,858
Income Before Provision for Income Taxes and Minority Interest
44,525
62,498
Provision for Income Taxes
18,866
24,212
Minority Interest in Earnings of Subsidiaries, Net
249
444
Net Income
25,410
37,842
Net Income per Share—Basic
0.19
0.29
Net Income per Share—Diluted
0.28
Weighted Average Common Shares Outstanding—Basic
130,474
131,929
Weighted Average Common Shares Outstanding—Diluted
131,470
133,445
Six Months EndedJune 30,
577,021
647,018
436,307
498,207
1,013,328
1,145,225
458,716
521,658
276,653
327,128
89,291
101,121
865
(11
825,525
949,896
187,803
195,329
93,028
93,832
9,609
(9,705
85,166
111,202
36,102
45,183
705
904
48,359
65,115
0.37
0.49
130,228
131,805
131,494
133,379
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
81,285
91,791
Amortization (includes deferred financing costs and bond discount of $2,416 and $2,466, respectively)
10,422
11,796
Stock compensation expense
2,146
5,823
Provision for deferred income taxes
29,365
32,843
Loss (Gain) on foreign currency and other, net
7,348
(11,432
Changes in Assets and Liabilities (exclusive of acquisitions):
Accounts receivable
(17,862
(23,828
Prepaid expenses and other current assets
(1,665
(11,117
7,272
4,629
Accrued expenses, deferred revenue and other current liabilities
21,186
1,484
Other assets and long-term liabilities
1,929
5,738
Cash Flows from Operating Activities
191,355
173,735
Cash Flows from Investing Activities:
Capital expenditures
(131,850
(154,971
Cash paid for acquisitions, net of cash acquired
(34,874
(68,857
Additions to customer relationship and acquisition costs
(6,695
(7,274
Investment in joint ventures
(3,129
Other, net
919
(732
Cash Flows from Investing Activities
(172,500
(234,963
Cash Flows from Financing Activities:
Repayment of debt and term loans
(307,048
(299,013
Proceeds from debt and term loans
275,405
339,056
Debt financing (repayment to) and equity contribution from (distribution to) minority stockholders, net
(1,769
(1,984
Proceeds from exercise of stock options and employee stock purchase plan
12,372
10,202
Payment of debt financing costs and stock issuance costs
(222
(15
Cash Flows from Financing Activities
(21,262
48,246
Effect of exchange rates on cash and cash equivalents
(18
521
Decrease in Cash and Cash Equivalents
(2,425
(12,461
Cash and Cash Equivalents, Beginning of Period
31,942
Cash and Cash Equivalents, End of Period
29,517
Supplemental Data:
Cash Paid for Interest
93,558
93,133
Cash Paid for Income Taxes
6,745
11,280
Non-Cash Investing Activities:
Capital Leases
1,165
8,608
Capital Expenditures
27,301
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 Current Report on Form 8-K dated May 22, 2006.
(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 expense (income), net, on our consolidated statements of operations. Included in other expense (income), net are $4,965 and $9,754 of net losses associated with foreign currency transactions for the three and six months ended June 30, 2005, respectively, and $7,186 and $8,515 of net gains associated with foreign currency transactions for the three and six months ended June 30, 2006, respectively.
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)
c. Goodwill and Other Intangible Assets
We apply the provisions of SFAS No. 142, “Goodwill and Other Intangible Assets.” Under SFAS No. 142, goodwill and intangible assets with indefinite lives are not amortized but are reviewed annually for impairment or more frequently if impairment indicators arise. Separable intangible assets that are not deemed to have indefinite lives are amortized over their useful lives.
We have selected October 1 as our annual goodwill impairment review date. We performed our last annual goodwill impairment review as of October 1, 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 June 30, 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 ended 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 six month period ended June 30, 2006 are as follows:
North American Physical Business
International Physical Business
Worldwide Digital Business
Total Consolidated
Balance as of December 31, 2005
1,543,037
463,742
131,862
Deductible Goodwill acquired during the period
3,265
7,810
11,075
Nondeductible Goodwill acquired during the period
3,358
7,802
11,160
Adjustments to purchase reserves
(373
430
9
66
Fair value adjustments
(173
(9,532
497
(9,208
Currency effects and other adjustments
6,866
27,606
161
34,633
Balance as of June 30, 2006
1,555,980
497,858
132,529
8
The components of our amortizable intangible assets at June 30, 2006 are as follows:
Gross Carrying
Accumulated
Net Carrying
Amount
Amortization
Customer Relationships and Acquisition Costs
287,512
43,610
Core Technology(1)
25,960
4,720
21,240
Non-Compete Agreements(1)
1,418
1,106
312
Deferred Financing Costs
46,910
17,864
Total
361,800
67,300
294,500
(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, for the three and six months ended June 30, 2005 was $1,103 ($833 after tax or $0.01 per basic and diluted share) and $2,146 ($1,692 after tax or $0.01 per basic and diluted share), respectively, and for the three and six months ended June 30, 2006 was $3,117 ($2,860 after tax or $0.02 per basic and diluted share) and $5,823 ($4,518 after tax or $0.03 per basic and diluted share), respectively, for Employee Stock-Based Awards. For the three and six months ended June 30, 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 $257 and $554, respectively, and net income to decrease by $158 and $340, respectively, 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, 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 three and six months ended June 30, 2005 based on SFAS No. 123R. The reported and pro forma net income and earnings per share for the three and six months ended June 30, 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 three and six months ended June 30, 2006 are included in the table below only to provide the detail for a comparative presentation to the same periods of 2005.
Net income, as reported
Add: Stock-based employee compensation expense included in reported net income, net of tax benefit
833
2,860
1,692
4,518
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of tax benefit
(1,135
(2,860
(2,333
(4,518
Net income, pro forma
25,108
47,718
Net Income per share:
Basic—as reported
Basic—pro forma
Diluted—as reported
Diluted—pro forma
0.36
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.
10
The weighted average fair value of options granted for the six months ended June 30, 2005 and 2006 was $10.38 and $14.64 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:
Six Months Ended
Weighted Average Assumption
June 30, 2005
June 30, 2006
Expected volatility
26.8%
24.7%
Risk-free interest rate
4.02%
4.75%
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 six months ended June 30, 2006 is as follows:
Options
WeightedAverageExercisePrice
WeightedAverageRemainingContractualTerm
AggregateIntrinsicValue
Outstanding at December 31, 2005
5,495,274
22.41
Granted
497,914
39.07
Exercised
(308,544
13.82
Forfeited
(73,216
25.96
Outstanding at June 30, 2006
5,611,428
24.30
6.6
73,398
Options exercisable at June 30, 2006
2,785,711
16.68
4.7
57,664
The aggregate intrinsic value of stock options exercised during the three and six months ended June 30, 2006 was approximately $2,964 and $8,169, respectively.
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 for the six months ended June 30, 2006 is a portion of the cost related to restricted stock granted in July 2005. We did not grant restricted stock in the first six months of 2006.
11
A summary of restricted stock activity for the six months ended June 30, 2006 is as follows:
RestrictedStock
Weighted-AverageGrant-DateFair Value
Non-vested at December 31, 2005
64,641
30.94
Vested
(26,106
Non-vested at June 30, 2006
38,535
The total fair value of shares vested for the three and six months ended June 30, 2006 was $1,003.
Employee Stock Purchase Plan
We offer an employee stock purchase plan in which participation is available to substantially all U.S. and Canadian employees who meet certain service eligibility requirements (the “ESPP”). The ESPP provides a way for our eligible employees to become stockholders on favorable terms. The ESPP provides for the purchase of our common stock by eligible employees through successive offering periods. We generally have two 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. For the six months ended June 30, 2005 and 2006, there were 193,890 shares and 193,778 shares, respectively, purchased under the ESPP. Beginning with the December 1, 2006 ESPP offering period, the price for shares purchased under the ESPP will be changed to 95% of the fair market price at the end of the offering period without a look back feature.
12
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
May 2005Offering
December 2005Offering
May 2006Offering
24.0%
27.5%
26.6%
20.1%
3.41%
3.96%
4.04%
6 months
The weighted average fair value for the ESPP options was $6.07, $6.02, $8.70 and $7.20 for the December 2004, May 2005, December 2005 and May 2006 offerings, respectively.
As of June 30, 2006, unrecognized compensation cost related to the unvested portion of our Employee Stock-Based Awards was $27,008 and is expected to be recognized over a weighted-average period of 4.1 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 995,719 and 1,515,643 shares for the three months ended June 30, 2005 and 2006, respectively, and 1,265,868 shares and 1,573,996 shares for the six months ended June 30, 2005 and 2006, respectively. Potential common shares of 569,643 and 495,302 for the three and six months ended June 30, 2005, respectively, and potential common shares of 580,113 and 463,483 for the three and six months ended June 30, 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
13
charges for related service activities and courier operations and the sale of software licenses and storage 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. 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. New Accounting Pronouncements
In July 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”), an interpretation of FASB Statement No. 109, “Accounting for Income Taxes” (“SFAS No. 109”).FIN 48 clarifies the accounting for uncertainty in income taxes recognized in a company’s financial statements in accordance with SFAS No. 109.FIN 48 also prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return.
The evaluation of a tax position in accordance with FIN 48 is a two-step process. The first step is a recognition process whereby the company determines whether it is more likely than not that a tax position will be sustained upon examination, including resolution of any related appeals or litigation processes, based on the technical merits of the position. The second step is a measurement process whereby a tax position that meets the more likely than not recognition threshold is calculated to determine the amount of benefit to recognize in the financial statements. The tax position is measured at the largest amount of benefit that is greater than 50% likely of being realized upon ultimate settlement.
The provisions of FIN 48 are effective January 1, 2007. Earlier application is permitted as long as the company has not yet issued financial statements, including interim financial statements, in the period of adoption. The provisions of FIN 48 are to be applied to all tax positions upon initial adoption of this standard. Only tax positions that meet the more likely than not recognition threshold at the effective date
14
may be recognized or continue to be recognized upon adoption of FIN 48. The cumulative effect of applying the provisions of FIN 48 should be reported as an adjustment to the opening balance of retained earnings for that fiscal year. We are in the process of evaluating the effect of FIN 48 on our consolidated results of operations and financial position.
h. 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.
(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
1,398
11,843
3,753
10,061
Market Value Adjustments for Hedging Contracts, Net of Tax
715
1,839
262
Market Value Adjustments for Securities, Net of Tax
(20
Comprehensive Income
27,503
49,740
53,940
75,451
15
(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 previously 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. Both of these swap agreements expired in the first quarter of 2006. As a result of the foregoing, for the three and six months ended June 30, 2005, we recorded additional interest expense of $1,235 and $2,768, respectively, and for the three months ended March 31, 2006, we recorded additional interest expense of $127, 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 the accompanying consolidated balance sheet, the estimated cost to terminate this swap (fair value of the derivative liability) of $818 (which was recorded in accrued expenses) as of June 30, 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 interest expense of $1,035 and interest income of $393 for the three and six months ended June 30, 2005, respectively, and interest income of $410 and $978 for the three and six months ended June 30, 2006.
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 multi-currency term loan facility. As of June 30, 2006, both of these swap agreements had expired. For the three and six months ended June 30, 2005, we recorded additional interest income of $23 and $43, respectively, and for the three and six months ended June 30, 2006, we recorded interest expense of $71 and $184, respectively, resulting from interest rate swap cash payments.
Subsequent to its second quarter of 2006, IME entered into a floating for fixed interest rate swap contract with a notional value of 75,000 British pounds sterling, which will expire on March 2008 and was designated as a cash flow hedge. This swap agreement hedges interest rate risk on IME’s 100,000
16
(4) Derivative Instruments and Hedging Activities (Continued)
British pounds multi-currency term loan facility. The notional value of the swap will decline to 60,000 British pounds sterling in March 2007 to match the remaining term loan amount outstanding as of that date.
(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 augmented by cash provided by operating activities and cash equivalents on-hand.
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)
49,204
Fair Value of Identifiable Net Assets Acquired:
Fair Value of Identifiable Assets Acquired(2)
(32,590
Liabilities Assumed(3)
6,540
Minority Interest(4)
(919
Total Fair Value of Identifiable Net Assets Acquired
(26,969
Recorded Goodwill
22,235
(1) Included in cash paid for acquisitions in the consolidated statements of cash flows for the six months ended June 30, 2006 are contingent payments totaling $21,382 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 $15,963 for the six months ended June 30, 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.
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 June 30, 2006 primarily include completion of planned abandonments of facilities and severance contracts in connection with certain acquisitions.
17
(5) Acquisitions (Continued)
The following is a summary of reserves related to such restructuring activities:
Year EndedDecember 31, 2005
Six MonthsEndedJune 30, 2006
Reserves, Beginning Balance
21,414
12,698
Reserves Established
1,142
1,465
Expenditures
(7,360
(2,694
Adjustments to Goodwill, including currency effect(1)
(2,498
197
Reserves, Ending Balance
11,666
(1) Includes adjustments to goodwill as a result of finalizing our restructuring plans.
At June 30, 2006, the restructuring reserves related to acquisitions consisted of lease losses on abandoned facilities ($8,656), severance costs ($418), and move and other exit costs ($2,592). These accruals are expected to be used prior to June 30, 2007 except for lease losses ($6,670) and severance contracts ($144), both of which are based on contracts that extend beyond one year.
(6) Long-term Debt
Long-term debt consists of the following:
December 31, 2005
CarryingAmount
FairValue
IMI Revolving Credit Facility(1)
216,396
249,602
IMI Term Loan Facility(1)
345,500
343,750
IME Revolving Credit Facility(1)
84,262
104,928
IME Term Loan Facility(1)
177,450
182,630
81¤4% Senior Subordinated Notes due 2011(2)
149,760
151,500
149,782
149,250
85¤8% Senior Subordinated Notes due 2013(2)
481,032
502,513
481,022
483,278
71¤4% GBP Senior Subordinated Notes due 2014(2)
258,120
250,376
272,445
261,220
73¤4% Senior Subordinated Notes due 2015(2)
439,506
435,568
439,049
414,005
65¤8% Senior Subordinated Notes due 2016(2)
315,059
299,200
315,306
287,200
Real Estate Mortgages(1)
4,707
4,420
Seller Notes(1)
9,398
8,189
Other(1)
48,241
56,635
Total Long-term Debt
2,529,431
2,607,758
Less Current Portion
(25,905
(65,762
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 June 30, 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 June 30, 2006.
18
(6) Long-term Debt (Continued)
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 multi-currency 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 June 30, 2006 included 100,000 British pounds sterling and 82,966 Euro of borrowings (totaling $287,558) under the IME Credit Agreement; we also had various outstanding letters of credit totaling 1,731 British pounds sterling ($3,161). The remaining availability, based on its current level of external debt and the leverage ratio under the IME revolving credit facility on April 30, 2006, was approximately 40,815 British pounds sterling ($74,540). The interest rates in effect under the IME revolving credit facility ranged from 3.9% to 5.9% as of April 30, 2006. For the three and six months ended June 30, 2005, we recorded commitment fees of $213 and $419, respectively, based on 0.9% of unused balances under the IME revolving credit facility. For the three and six months ended June 30, 2006, we recorded commitment fees of $117 and $254, respectively, based on 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
19
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 June 30, 2006, we had $249,602 of borrowings under our IMI revolving credit facility, of which $29,500 was denominated in U.S. dollars and the remaining balance was denominated in Canadian dollars (CAD 188,000), in Australian dollars (AUD 55,000) and in New Zealand dollars (NZD 20,200); we also had various outstanding letters of credit totaling $23,900. The remaining availability, based on Iron Mountain Incorporated’s (“IMI”) current level of external debt and the leverage ratio under the IMI revolving credit facility, on June 30, 2006 was $126,498. The interest rate in effect under the IMI revolving credit facility and IMI term loan facility ranged from 5.5% to 9.1% and 7.0% to 7.9%, respectively, as of June 30, 2006. For the three and six months ended June 30, 2005, we recorded commitment fees of $186 and $443, respectively, and for the three and six months ended June 30, 2006, we recorded commitment fees of $98 and $224, respectively, based on 0.4% 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 June 30, 2006.
20
(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 June 30, 2006 and for the three and six months ended June 30, 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
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
21
(7) Selected Financial Information of Parent, Guarantors and Non-Guarantors (Continued)
Non-Guarantors
9,374
31,578
299,524
140,761
868,151
(868,151
66,263
42,922
(874
108,359
868,199
375,161
215,261
(869,025
1,262,169
613,347
2,123,348
11,044
(2,134,392
584,250
292,750
(877,000
1,489,695
686,931
24,945
133,952
147,470
(934
305,433
2,732,543
1,927,441
834,401
(3,002,585
3,600,742
3,564,771
1,663,009
(3,871,610
242,039
626,112
4,073
5,256
56,433
48,380
346,035
149,911
543,452
2,079,833
14,555
447,608
10,044
267,410
66,687
337,016
958
4,125
566,128
305,256
(871,384
22
Three Months Ended June 30, 2005
212,449
79,217
Service and Storage Material Sales
157,123
63,133
369,572
142,350
Cost of Sales (Excluding Depreciation)
160,096
67,992
Selling, General and Administrative
28
107,527
33,758
Depreciation and Amortization
32,124
12,599
Loss on Disposal/Writedown of Property, Plant and Equipment, Net
1,075
300,822
114,357
Operating (Loss) Income
(50
68,750
27,993
Interest Expense (Income), Net
39,088
(8,292
16,426
Equity in the Earnings of Subsidiaries, Net of Tax
(53,065
(5,420
58,485
Other (Income) Expense, Net
(11,483
14,608
1,821
67,854
9,746
(58,485
15,260
3,606
52,594
5,891
23
Three Months Ended June 30, 2006
238,241
89,622
170,273
83,432
408,514
173,054
173,065
86,225
62
127,108
41,115
35,370
15,886
(Gain) Loss on Disposal/Writedown of Property, Plant and Equipment, Net
331
(505
79
335,874
142,721
(79
72,640
30,333
41,033
(6,491
12,712
(91,223
(11,122
102,345
12,269
(19,617
490
109,870
17,131
(102,345
19,648
4,564
90,222
12,123
24
Six Months Ended June 30, 2005
420,502
156,519
310,157
126,150
730,659
282,669
321,501
137,215
82
207,836
68,735
31
64,400
24,860
Loss (Gain) on Disposal/Writedown of Property, Plant and Equipment, Net
872
(7
113
594,609
230,803
(113
136,050
51,866
78,177
(16,545
31,396
(107,883
(9,945
117,828
(18,766
25,541
2,834
136,999
17,636
(117,828
29,951
6,151
107,048
10,780
25
Six Months Ended June 30, 2006
470,489
176,529
339,891
158,316
810,380
334,845
353,293
168,365
(90
248,208
79,010
37
70,681
30,403
298
(309
(53
672,480
277,469
137,900
57,376
81,566
(15,893
28,159
(159,605
(19,464
179,069
12,977
(20,874
(1,808
194,131
31,025
(179,069
36,195
8,988
157,936
21,133
26
(76,219
226,011
41,563
(90,247
(41,603
(15,564
(19,310
Intercompany loans to subsidiaries
84,458
(29,893
(54,565
Investment in subsidiaries
(15,686
31,372
(3,443
(3,252
903
68,772
(153,930
(64,149
(23,193
(202,700
(791
(103,557
197,818
77,587
Debt financing (repayment to) and equity contribution from (distribution to) minority shareholders, net
Intercompany loans from parent
(85,201
30,636
54,565
Equity contribution from parent
15,686
(31,372
Proceeds form exercise of stock options and employee stock purchase plan
(43
(179
7,447
(70,306
18,404
23,193
Increase (Decrease) in cash and cash equivalents
1,775
(4,200
Cash and cash equivalents, beginning of period
11,021
20,921
Cash and cash equivalents, end of period
12,796
16,721
27
(73,772
198,365
49,142
(111,673
(43,298
(16,791
(52,066
67,934
11,859
(79,793
(13,760
27,520
(4,837
(2,437
(1,476
(2,385
(3,861
54,174
(136,678
(100,186
(52,273
(281,862
(6,278
(10,873
291,273
47,783
(70,453
(9,340
79,793
13,760
(27,520
19,598
(62,971
39,346
52,273
(1,284
(11,177
(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 server data and intellectual property management services, which were previously included in our Data Protection segment, are now included in the Worldwide Digital Business 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—information protection and storage services for electronic records conveyed via telecommunication lines and the Internet, including online backup and recovery solutions for 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, Data Protection and Shredding
· Asia Pacific—information protection and storage services throughout Australia, New Zealand and India, 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.
29
(8) Segment Information (Continued)
An analysis of our business segment information and reconciliation to the consolidated financial statements is as follows:
NorthAmericanPhysicalBusiness
InternationalPhysicalBusiness
WorldwideDigitalBusiness
TotalConsolidated
378,795
108,788
24,339
28,565
10,473
5,707
Contribution
114,295
28,293
(67
142,521
Expenditures for Segment Assets(1)
44,900
19,141
14,636
78,677
415,254
132,182
34,132
31,534
12,987
6,752
119,094
31,467
3,432
153,993
67,940
56,534
6,606
131,080
749,715
216,246
47,367
57,155
20,607
11,529
225,037
53,383
(461
277,959
3,260,603
1,072,996
206,856
4,540,455
101,451
54,199
17,769
173,419
825,155
255,153
64,917
62,062
25,338
13,721
233,078
60,575
2,786
296,439
3,469,504
1,251,683
235,725
134,486
85,755
10,861
231,102
(1) Includes capital expenditures, cash paid for acquisitions, net of cash acquired and additions to customer 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
30
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.
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 Current Report on Form 8-K dated May 22, 2006 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.
(10) Subsequent Events
In July 2006, we completed an underwritten public offering of $200,000 in aggregate principal amount of our 83¤4% Senior Subordinated Notes due 2018, which were issued at a price to investors at par.
(10) Subsequent Events (Continued)
Our net proceeds of approximately $196,800, after paying the underwriters’ discounts, commissions and transaction fees, were used to (a) fund our offer to purchase and consent solicitation relating to our outstanding 81¤4% Senior Subordinated Notes due 2011, (b) fund our purchase in the open market of $33,000 in aggregate principal amount of our other Senior Subordinated Notes and (c) repay borrowings under our revolving credit facility. As a result, we will record a charge to other expense (income), net of approximately $3,000 in the third quarter of 2006 related to the early extinguishment of the 81¤4% and other Senior Subordinated Notes, which consists of tender premiums, transaction costs, deferred financing costs, as well as, original issue discounts and premiums related to the 81¤4% and other Senior Subordinated Notes.
In July 2006, we experienced a significant fire in a records and information facility in London, England that resulted in the complete destruction of the leased facility. We believe we carry adequate property and liability insurance and are in the process of assessing the cause of, and other circumstances involved with, the fire. We do not expect that this event will have a material impact to our consolidated results of operations or financial condition. Revenues from this facility represent less than 1% of our consolidated enterprise revenues.
32
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion and analysis of our financial condition and results of operations for the three and six months ended June 30, 2006 should be read in conjunction with our consolidated financial statements and notes thereto for the three and six months ended June 30, 2006 included herein, and the year ended December 31, 2005, included in our Current Report on Form 8-K dated May 22, 2006.
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 and our Current Report on Form 8-K filed on July 11, 2006. 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 Securities and Exchange Commission (“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 United 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
141,438
154,167
277,094
296,450
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
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· Accounting for Internal Use Software
· 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 Current Report on 8-K dated May 22, 2006 as filed with the SEC. Management has determined that no material changes concerning our critical accounting policies have occurred since December 31, 2005.
Recent Accounting Pronouncements
The provisions of FIN 48 are effective January 1, 2007. Earlier application is permitted as long as the company has not yet issued financial statements, including interim financial statements, in the period of adoption. The provisions of FIN 48 are to be applied to all tax positions upon initial adoption of this standard. Only tax positions that meet the more likely than not recognition threshold at the effective date may be recognized or continue to be recognized upon adoption of FIN 48. The cumulative effect of applying the provisions of FIN 48 should be reported as an adjustment to the opening balance of retained earnings for that fiscal year. We are in the process of evaluating the effect of FIN 48 on our consolidated results of operations and financial position.
Overview
The following discussions set forth, for the periods indicated, management’s discussion and analysis of results. Significant trends and changes are discussed for the three and six month periods ended June 30, 2006 within each section. Trends and changes that are consistent within the three and six months periods are not repeated and are discussed only on a year to date basis.
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Results of Operations
Comparison of Three and Six Months Ended June 30, 2006 to Three and Six Months Ended June 30, 2005 (in thousands):
DollarChange
Percent Change
Revenues
69,646
13.6
%
Operating Expenses
63,445
15.3
6,201
6.4
Other Expenses, Net
71,283
65,052
(6,231
(8.7
)%
12,432
48.9
OIBDA(1)
12,729
9.0
OIBDA Margin(1)
27.6
26.5
Six Months Ended June 30,
Dollar Change
131,897
13.0
124,371
15.1
7,526
4.0
139,444
130,214
(9,230
(6.6
16,756
34.6
19,356
7.0
27.3
25.9
(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 $36.2 million, or 12.4%, to $327.9 million and $70.0 million, or 12.1%, to $647.0 million for the three and six months ended June 30, 2006 compared to the same periods in 2005, respectively. For both the three and six month periods ended June 30, 2006, the increase is attributable to internal revenue growth (11%) 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 $33.4 million, or 15.2%, to $253.7 million and $61.9 million, or 14.2%, to $498.2 million for the three and six months ended June 30, 2006, respectively, compared to the same periods in 2005. For the three months ended June 30, 2006 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 (8%), net of a decrease due to foreign currency exchange rate fluctuations (1%). For the six months ended June 30, 2006, 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 (7%), net of a decrease due to foreign currency exchange rate fluctuations (1%).
For the reasons stated above, our consolidated revenues increased $69.6 million, or 13.6%, to $581.6 million and $131.9 million, or 13.0%, to $1,145.2 million for the three and six months ended
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June 30, 2006, respectively, compared to the same periods in 2005. Foreign currency exchange rate fluctuations that impacted our revenues were primarily 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 9% for both the three and six months ended June 30, 2006. We calculate internal revenue growth in local currency for our international operations.
Internal Growth—Eight-Quarter Trend
2004
ThirdQuarter
FourthQuarter
FirstQuarter
SecondQuarter
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 10% to 11%. 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 and fulfillment businesses. 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.
OPERATING EXPENSES
Cost of Sales
Consolidated cost of sales (excluding depreciation) is comprised of the following expenses (in thousands):
Dollar
Percent
% ofConsolidatedRevenues
PercentChange(Favorable)/
Change
Unfavorable
Labor
112,609
128,353
15,744
14.0
22.0
22.1
0.1
Facilities
65,226
74,500
9,274
14.2
12.7
12.8
Transportation
23,951
26,937
2,986
12.5
4.6
(0.1
Product Cost of Sales
11,662
11,835
173
1.5
2.3
2.0
(0.3
14,640
17,665
3,025
20.7
2.9
3.0
31,202
13.7
44.6
222,870
254,060
31,190
22.2
0.2
135,977
154,936
18,959
13.9
13.4
13.5
46,647
53,465
6,818
14.6
23,639
24,848
1,209
5.1
2.2
29,583
34,349
4,766
16.1
62,942
45.3
45.6
0.3
For the six months ended June 30, 2006 as compared to the six months ended June 30, 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 shredding 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 13.5% for the six months ended June 30, 2006 from 13.4% for the six months ended June 30, 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 six months ended June 30, 2006 compared to the six months ended June 30, 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 $8.7 million for the six months ended June 30, 2006 compared to the six months ended June 30, 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.
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Our transportation expenses, which increased slightly as a percentage of consolidated revenues for the six months ended June 30, 2006 compared to the six months ended June 30, 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, offset by a reduction in third party subcontractor courier costs, during the six months ended June 30, 2006 compared to the six months ended June 30, 2005, were primarily responsible for the increase in transportation expenses as a percentage of consolidated revenues.
Product and Other Costs of Sales
Product and other costs of sales are highly correlated to complementary revenue streams. Total product and other costs of sales for the six months ended June 30, 2006 were flat compared to the six months ended June 30, 2005.
Selling, General and Administrative Expenses
Selling, general and administrative expenses are comprised of the following expenses (in thousands):
General and Administrative
72,199
83,808
11,609
14.1
14.4
Sales, Marketing & Account Management
44,036
52,991
8,955
20.3
8.6
9.1
0.5
Information Technology
24,114
29,843
5,729
23.8
0.4
Bad Debt Expense
964
1,643
679
70.4
26,972
19.1
28.9
1.3
140,280
162,938
22,658
16.2
13.8
86,681
104,584
17,903
47,948
57,564
9,616
20.1
5.0
1,744
2,042
17.1
50,475
18.2
28.6
The increase in general and administrative expenses as a percentage of consolidated revenues for the six months ended June 30, 2006 compared to the six months ended June 30, 2005 is mainly attributable to (a) increased compensation expense due to expansion through acquisitions, (b) costs associated with our North American reorganization which added a new level of field management, (c) 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, and (d) increased management recruiting fees and professional fees.
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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 six months ended June 30, 2006. Throughout 2005 and into 2006, we invested in the expansion and improvement of our sales, marketing and account management functions. In North America, while our sales force headcount has increased at a slower rate than revenue growth, the shift to higher end resources is driving an increase in the level of spending due to higher costs per sales person and the additional support required. We have significantly increased the size of our digital sales force through acquisition (LiveVault) and the hiring of new sales people, particularly in Europe. 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 $5.1 million increase in sales commissions and an increase of $6.8 million of compensation expense for the six months ended June 30, 2006 compared to the six months ended June 30, 2005.
Information technology expenses increased as a percentage of consolidated revenues for the six months ended June 30, 2006 compared to the six months ended June 30, 2005 due to increases in technology development activities within our digital services business, including the acquisition of LiveVault and associated research and development activities and increased spending to support our growing digital archiving business. 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.
Depreciation, Amortization and (Gain) Loss on Disposal/Writedown of Property, Plant and Equipment, Net
Consolidated depreciation and amortization expense increased $11.8 million to $101.1 million (8.8% of consolidated revenues) for the six months ended June 30, 2006 from $89.3 million (8.8% of consolidated revenues) for the six months ended June 30, 2005. Depreciation expense increased $5.7 million and $10.5 million for the three and six months ended June 30, 2006 compared to the same periods in 2005, respectively, primarily due to the additional depreciation expense related to recent capital expenditures and acquisitions, including storage systems, which consist of racking, building and leasehold improvements, computer systems hardware and software, and buildings. Amortization expense increased $0.8 million and $1.3 million for the three and six months ended June 30, 2006 compared to the same periods in 2005, respectively, primarily 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 $6.2 million, or 6.4%, to $102.9 million (17.7% of consolidated revenues) for the three months ended June 30, 2006 from $96.7 million (18.9% of consolidated revenues) for the three months ended June 30, 2005. Consolidated operating income increased $7.5 million, or 4.0%, to $195.3 million (17.1% of consolidated revenues) for the six months ended June 30, 2006 from $187.8 million (18.5% of consolidated revenues) for the six months ended June 30, 2005.
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As a result of the foregoing factors, consolidated OIBDA increased $12.7 million, or 9.0% to $154.2 million (26.5% of consolidated revenues) for the three months ended June 30, 2006 from $141.4 million (27.6% of consolidated revenues) for the three months ended June 30, 2005. Consolidated OIBDA increased $19.4 million, or 7.0% to $296.4 million (25.9% of consolidated revenues) for the six months ended June 30, 2006 from $277.1 million (27.3% of consolidated revenues) for the six months ended June 30, 2005.
OTHER EXPENSES, NET
Consolidated interest expense, net remained flat at $47.2 million for both the three months ended June 30, 2006 and 2005, and increased $0.8 million to $93.8 million from $93.0 million for the six months ended June 30, 2006. The change is 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 7.4% as of June 30, 2006 from 7.6% as of June 30, 2005.
Other Expense (Income), Net (in thousands)
Foreign currency transaction losses (gains), net
4,965
(7,186
(12,151
9,754
(8,515
(18,269
(19
328
347
(145
(1,190
(1,045
(11,804
(19,314
Foreign currency gains of $8.5 million based on period-end exchange rates were recorded in the six months ended June 30, 2006, primarily due to the strengthening of the British pound sterling, Canadian dollar, 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 European subsidiaries, borrowings denominated in certain foreign currencies under our revolving credit facility and British pounds sterling denominated debt held by our U.S. parent company.
Foreign currency losses of $9.8 million based on period-end exchange rates were recorded in the six months ended June 30, 2005 primarily due to the weakening of the British pound sterling, Canadian dollar and the Euro against the U.S. dollar since December 31, 2004 as these currencies relate to our intercompany balances with our U.K., Canadian 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 June 30, 2005 and 2006 were 42.4% and 38.7%, respectively. Our effective tax rates for the six months ended June 30, 2005 and 2006 were 42.4%, and 40.6%, respectively. The primary reconciling item between the statutory rate of 35% and our effective rate is state income taxes (net of federal benefit). During the second quarter of 2006, we recorded a reduction in income tax expense as a result of a new Texas law changing the way state income tax is calculated in that state. As a result of this change, we have reversed a deferred tax liability of $1.7 million, net of federal tax benefit, related to our Texas state taxes. 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
41
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 $0.4 million and $0.9 million for the three and six months ended June 30, 2006, respectively, compared to $0.2 million and $0.7 million for the three and six months ended June 30, 2005, respectively. This represents our minority partners’ share of earnings in our majority-owned international subsidiaries that are consolidated in our operating results.
NET INCOME
As a result of the foregoing factors, consolidated net income increased $12.4 million, or 48.9%, to $37.8 million (6.5% of consolidated revenues) for the three months ended June 30, 2006 from net income of $25.4 million (5.0% of consolidated revenues) for the three months ended June 30, 2005. For the six months ended June 30, 2006, consolidated net income increased $16.8 million, or 34.6%, to $65.1 million (5.7% of consolidated revenues) from net income of $48.4 million (4.8% of consolidated revenues) for the six months ended June 30, 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 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.
Segment Revenue
Percentage
SegmentContribution(1)
SegmentContributionas a Percentageof SegmentRevenue
June 30,2005
June 30,2006
Increase inRevenues
Three Months Ended
36,459
9.6
30.2
28.7
75,440
10.1
30.0
28.2
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Items Excluded from the Calculation of Contribution(1)
(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 six months ended June 30, 2006, revenue in our North American Physical Business segment increased 10.1% 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 and fulfillment, growth of our secure shredding operations, and acquisitions. In addition, favorable currency fluctuations during the six months ended June 30, 2006 in Canada increased revenue, as measured in U.S. dollars, by $6.0 million when compared to the six months ended June 30, 2005. Contribution as a percent of segment revenue decreased in the six months ended June 30, 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 half of 2006 but not in the first half 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.
SegmentContributionas a Percentage ofSegment Revenue
23,394
21.5
26.0
38,907
18.0
24.7
23.7
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Revenue in our International Physical Business segment increased 18.0% during the six months ended June 30, 2006. This increase was due to the acquisition of Pickfords in December 2005, which contributed $19.4 million in revenue, an increase of $11.8 million in Europe (net of a $17.5 million unfavorable currency fluctuation), and an increase of $7.8 million in Latin America (net of a $2.2 million favorable currency fluctuation). Contribution as a percent of segment revenue decreased primarily due to increases in European recruitment fees, new management, sales, and marketing personnel, and the acquisition of shredding businesses that operate at lower margins, off set by a decrease in bad debt expense.
Segment Contributionas a Percentage ofSegment Revenue
9,793
40.2
17,550
37.1
(1.0
4.3
During the three and six months ended June 30, 2006, revenue in our Worldwide Digital Business segment increased 40.2% and 37.1% compared to the three and six months ended June 30, 2005, on internal growth of 31% and 29%, respectively, primarily attributable to our online backup service offerings for both personal computer and server data. The acquisition of LiveVault in December 2005, contributed $2.8 million and $5.0 million in revenue during the three and six months ended June 30, 2006, respectively. Contribution as a percent of segment revenue increased during both periods primarily due to increased revenues which resulted in a higher absorption of fixed costs and a reduction in royalty payments offset by increased overhead due to the acquisition of LiveVault, increased investment in the European sales force, and increases in information technology costs.
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Liquidity and Capital Resources
The following is a summary of our cash balances and cash flows for the six months ended June 30, 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 $173.7 million for the six months ended June 30, 2006 compared to $191.4 million for the six months ended June 30, 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 in 2006 compared to 2005 and timing of prepaid items such as real estate taxes.
Due to the nature of our businesses, we make significant capital expenditures and additions to customer 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 acquisition costs during the six months ended June 30, 2006 amounted to $162.2 million. For the six months ended June 30, 2006, capital expenditures, net and additions to customer acquisition costs were funded with cash flows provided by operating activities. 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 six months ended June 30, 2006, we paid net cash consideration of $68.9 million for acquisitions, primarily related to the acquisition of two shredding businesses in the U.K., the buyout of minority partners in France and Mexico and contingent payments associated with a shredding acquisition in the U.S. and another acquisition in Europe. Cash flows provided by operating activities, borrowings under our revolving credit facilities and cash equivalents on-hand funded these acquisitions.
Net cash provided by financing activities was $48.2 million for the six months ended June 30, 2006. During the six months ended June 30, 2006, we had gross borrowings under our revolving credit facilities and term loan facilities of $339.1 million and $10.2 million of proceeds from the exercise of stock options and employee stock purchase plan. We used the proceeds from these financing transactions to repay debt and term loans ($299.0 million), repay debt financing from minority stockholders, net ($2.0 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 June 30, 2006 was comprised of the following (in thousands):
IME Revolving Credit Facility(2)
IME Term Loan Facility(2)
81¤4% Senior Subordinated Notes due 2011(3)
85¤8% Senior Subordinated Notes due 2013(3)
71¤4% GBP Senior Subordinated Notes due 2014(3)
73¤4% Senior Subordinated Notes due 2015(3)
65¤8% Senior Subordinated Notes due 2016(3)
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) Most of IME’s non-dormant subsidiaries have either guaranteed this indebtedness or their shares of capital stock and inercompany indebtedness has been pledged to secure this indebtedness. IMI has not guaranteed or otherwise provided security for this indebtedness nor have any of IMI’s U.S., Canadian, Asia Pacific, Mexican or South American subsidiaries.
(3) These debt instruments are fully and unconditionally guaranteed, on a senior subordinated basis, by substantially all of our direct and indirect wholly owned U.S. subsidiaries (the “Guarantors”). These guarantees are joint and several obligations of the Guarantors. The remainder of our subsidiaries do not guarantee these debt instruments.
Our indentures use OIBDA-based calculations as primary measures of financial performance, including leverage ratios. Our key bond leverage ratio, as calculated per our bond indentures, was 5.0 and 4.7 as of December 31, 2005 and June 30, 2006, respectively. Noncompliance with this leverage ratio would have a material adverse effect on our financial condition and liquidity. Our target for this ratio is generally in the range of 4.5 to 5.5 while the maximum ratio allowable under the bond indentures is 6.5.
Our ability to pay interest on or to refinance our indebtedness depends on our future performance, working capital levels and capital structure, which are subject to general economic, financial, competitive, legislative, regulatory and other factors which may be beyond our control. There can be no assurance that we will generate sufficient cash flow from our operations or that future financings will be available on acceptable terms or in amounts sufficient to enable us to service or refinance our indebtedness, or to make necessary capital expenditures.
Our consolidated balance sheet as of June 30, 2006 includes 100.0 million British pounds sterling and 83.0 million Euro of borrowing (totaling $287.6 million) under the IME Credit Agreement; we also had various outstanding letters of credit totaling 1.7 million British pounds sterling ($3.2 million). The remaining availability, based on its current level of external debt and the leverage ratio under the IME revolving credit facility on April 30, 2006, was approximately 40.8 million British pounds sterling ($74.5 million). The interest rates in effect under the IME revolving credit facility ranged from 3.9% to 5.9% as of April 30, 2006.
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As of June 30, 2006, we had $249.6 million of borrowings under the IMI revolving credit facility, of which $29.5 was denominated in U.S. dollars and the remaining balance was denominated in Canadian dollars (CAD 188.0 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 $23.9 million. The remaining availability, based on Iron Mountain Incorporated’s (“IMI”) current level of external debt and the leverage ratio under the IMI revolving credit facility, on June 30, 2006 was $126.5 million. The interest rate in effect under the IMI revolving credit facility and IMI term loan facility ranged from 5.5% to 9.1% and 7.0% to 7.9%, respectively, as of June 30, 2006.
The IME Credit Agreement, IMI Credit Agreement and our indentures and other agreements governing our indebtedness contain certain restrictive financial and operating covenants, including covenants that restrict our ability to complete acquisitions, pay cash dividends, incur indebtedness, make investments, sell assets and take certain other corporate actions. The covenants do not contain a rating trigger. Therefore, a change in our debt rating would not trigger a default under the IME Credit Agreement, IMI Credit Agreement and our indentures and other agreements governing our indebtedness. We were in compliance with all material debt covenants as of June 30, 2006.
In July 2006, we completed an underwritten public offering of $200,000 in aggregate principal amount of our 83¤4% Senior Subordinated Notes due 2018, which were issued at a price to investors of 100% of par. Our net proceeds of approximately $196,800, after paying the underwriters’ discounts, commissions and transaction fees, were used to (a) fund our offer to purchase and consent solicitation relating to our outstanding 81¤4% Senior Subordinated Notes due 2011, (b) fund our purchase in the open market of $33,000 in aggregate principal amount of our other Senior Subordinated Notes and (c) repay borrowings under our revolving credit facility. As a result, we will record a charge to other expense (income), net of approximately $3,000 in the third quarter of 2006 related to the early extinguishment of the 81¤4% and other Senior Subordinated Notes, which consists of tender premiums, transaction costs, deferred financing costs, as well as, original issue discounts and premiums related to the 81¤4% and other Senior Subordinated Notes.
In July 2006, we experienced a significant fire in a records and information facility in London, England that resulted in the complete destruction of the leased facility. We believe we carry adequate property and liability insurance and are in the process of assessing the cause of, and other circumstances involved with, the fire. We do not expect that this event will have a material impact to our consolidated results of operations or financial condition or liquidity.
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 June 30, 2006, we had estimated net operating loss carryforwards of approximately $79 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.
47
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.
As of June 30, 2006, excluding the affect of the swap described below, we had $801.4 million of variable rate debt outstanding with a weighted average variable interest rate of 6.0%, and $1,806.4 million of fixed rate debt outstanding. As of June 30, 2006, 69% 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 June 30, 2006 would have been reduced by $1.2 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 June 30, 2006.
Subsequent to its second quarter of 2006, Iron Mountain Europe Limited (“IME”) entered into a floating for fixed interest rate swap contract with a notional value of 75,000 British pounds sterling, which will expire on March 2008 and was designated as a cash flow hedge. This swap agreement hedges interest rate risk on IME’s 100,000 British pounds multi-currency term loan facility. The notional value of the swap will decline to 60,000 British pounds sterling in March 2007 to match the remaining term loan amount outstanding as of that date.
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 IMI 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 June 30, 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 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 June 30, 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 June 30, 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 1A. Risk Factors
There are no material changes from the risk factors previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2005, other than the insertion of one additional risk factor as previously disclosed in our Current Report on Form 8-K filed on July 11, 2006.
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 June 30, 2006:
Issuer Purchases of Equity Securities
Period
Total Number of Shares Purchased(1)
Average Price Paid per Share
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs
Maximum Number (or Approximate Dollar Value) of Shares that May Yet Be Purchased Under the Plans or Programs
May 1, 2006-May 31, 2006
914
36.33
(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 4. Submission of Matters to a Vote of Security-Holders
The following matters were voted on by our stockholders at the Annual Meeting of Stockholders held on May 25, 2006.
(a) Election of directors to serve until the Year 2007 Annual Meeting of Stockholders, or until their successors are elected and qualified
Total Votes ForEach Director
Total Votes WithheldFrom Each Director
BrokerNon-votes
Clarke H. Bailey
100,344,468
24,801,908
0
Constantin R. Boden
122,837,357
2,309,019
Kent P. Dauten
124,027,761
1,118,615
John F. Kenny, Jr.
122,088,421
3,057,955
Arthur D. Little
123,192,135
1,954,240
C. Richard Reese
123,171,345
1,975,031
Vincent J. Ryan
121,766,851
3,379,525
(b) Approval of an amendment to the Amended and Restated Certificate of Incorporation of Iron Mountain Incorporated to increase the number of authorized shares of Common Stock from 200,000,000 to 400,000,000
For
Against
Abstain
120,488,107
4,614,883
43,386
(c) Approval of an amendment to the Iron Mountain Incorporated 2002 Stock Incentive Plan to increase the number of shares of Common Stock authorized for issuance thereunder from 3,352,543 to 8,352,543
107,676,909
2,442,716
50,954
14,975,797
(d) Approval of an amendment to the Iron Mountain Incorporated 2003 Senior Executive Incentive Program to increase the maximum compensation payable thereunder and modify and to re-approve the payment criteria thereunder
107,648,777
2,435,991
85,811
(e) Approval of the adoption of the Iron Mountain Incorporated 2006 Senior Executive Incentive Program
108,931,222
1,170,542
68,815
(f) Ratification of the selection by the Audit Committee of Deloitte & Touche LLP as the Company’s independent registered public accounting firm for the year ending December 31, 2006
124,862,434
247,245
36,697
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Item 6. Exhibits
(a) Exhibits
Exhibit No.
Description
4.1
Third Supplemental Indenture, dated as of July 17, 2006, by and among Iron Mountain Incorporated, the Guarantors named therein and The Bank of New York Trust Company, N.A., as trustee, supplementing the Senior Subordinated Indenture, dated as of December 30, 2002, by and among Iron Mountain Incorporated, the Guarantors named therein and The Bank of New York Trust Company, N.A., as trustee. (Incorporated by reference to Iron Mountain Incorporated’s Current Report on Form 8-K dated July 20, 2006.)
4.2
Supplemental Indenture, dated as of July 24, 2006, by and among Iron Mountain Incorporated, the Guarantors named therein and The Bank of New York Trust Company, N.A., as trustee, supplementing the Indenture, dated as of April 26, 1999, by and among Iron Mountain Incorporated, the Guarantors named therein and The Bank of New York Trust Company, N.A., as trustee. (Incorporated by reference to Iron Mountain Incorporated’s Current Report on Form 8-K dated July 28, 2006.)
Second Amendment to the 2002 Stock Incentive Plan. (Incorporated by reference to Iron Mountain Incorporated’s Current Report on Form 8-K dated June 1, 2006.)
10.2
Second Amendment to the 2003 Senior Executive Incentive Program. (Incorporated by reference to Iron Mountain Incorporated’s Current Report on Form 8-K dated June 1, 2006.)
10.3
2006 Senior Executive Incentive Program. (Incorporated by reference to Iron Mountain Incorporated’s Current Report on Form 8-K dated June 1, 2006.)
10.4
Compensation Plan for Non-Employee Directors. (Incorporated by reference to Iron Mountain Incorporated’s Current Report on Form 8-K dated June 1, 2006.)
10.5
Composite Copy of the Multi-Currency Term, Revolving Credit Facilities Agreement, dated as of March 4, 2004, as amended and in effect on the date hereof, among Iron Mountain Europe Limited, certain lenders party thereto, Barclays Capital and The Governor and Company of the Bank of Scotland, as arrangers, and The Governor and Company of the Bank of Scotland as the facility agent, and security trustee.
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.
August 9, 2006
BY:
/s/ JOHN F. KENNY, Jr.
(DATE)
Executive Vice President,
Chief Financial Officer and Director
(Principal Financial Officer)