Iron Mountain Incorporated Q1 2010 Earnings Call Transcript

Apr.30.10 | About: Iron Mountain (IRM)

Iron Mountain Inc. (NYSE:IRM)

Q1 2010 Earnings Call

April 29, 2010 8:30am ET

Executives

Bob Brennan - Chief Executive Officer

Brian McKeon - Chief Financial Officer

Stephen Golden - Vice President of Investor Relation

Analysts

Kevin Mcveigh - Macquarie Research

Andrea Wirth - Robert W. Baird

Vance Edelson - Morgan Stanley

John Healy - Northcoast Research

Eric Boyer - Wells Fargo Securities

David Gold - Sidoti

Operator

Good morning. My name is Bonny and I will be your conference operator today. At this time I would like to welcome everyone to the Iron Mountain first quarter 2010 earnings call webcast. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. (Operator Instructions)

I would now like to turn the call over to Mr. Golden, Vice President of Investor Relation. Please go ahead, Sir.

Stephen Golden

Thank you, and welcome everyone to our 2010 first quarter earnings conference call. After my announcement this morning, Brian McKeon will review our financial results, followed by Bob Brennan’s CEO remarks. When Bob is finished with his comments we’ll open up the phones for our Q&A.

For our custom, we have a user controlled slide present on the Investor Relations page of our website at www.ironmountain.com. Referring now to slide 2; today’s earnings call and slide presentation will contain a number of forward-looking statements most notably our outlook for our 2010 financial performance.

All forward-looking statements are subject to risks and uncertainties. Please refer to today’s press release, the Safe Harbor language on this slide and our most recently filed annual report on Form 10-K, for a discussion of the major risk factors that could cause our actual results to be materially different from those contemplated in our forward-looking statements.

As a remainder, on our last earnings call we introduced two new metrics; adjusted OIBDA, and adjusted EPS, as part of our ongoing efforts to enhance our investor communications. We used several non-GAAP measures when presenting our financial results; adjusted OIBDA, adjusted EPS, and free cash flow before acquisition and investments among others are metrics we speak to frequently, and ones we believe to be important in evaluating our overall financial performance.

We provide additional information and a reconciliation of these non-GAAP measures to the appropriate GAAP measures as required by Red G at the Investor Relations page of our website, as well as in today’s press release.

With that, I would like to introduce our CFO, Brain McKeon.

Brain McKeon

Thanks Steven. Slide three highlights the key messages from today’s review. We posted solid results in the first quarter of 2010. Revenue growth of 7% was in line with expectations. Storage internal growth was solid at 4%. Service internal growth was 5%, as it’s strength in complementary service revenues, including benefits from higher paper prices offset continued softness in core services.

As we work to strengthen our revenue growth, we continue to drive strong profit and free cash flow performance. For the quarter we delivered adjusted OIBDA growth of 11%, driven by gross margin expansion of nearly 200 basis points. This expansion continues to be supported by productivity and pricing gains. Proper gain in capital efficiency drove year-to-date free cash flow of $54 million.

Adjusted EPS for the quarter was $0.23 per share, an increase of 19% compared to the same period last year. Our reported EPS was $0.12 per share, including the impacts of the higher effective rate and a change in fiscal year end for Iron Mountain Europe from October 31 to December 31. I’ll discuss these items more fully later in my remarks.

Overall Q1 was a solid start to the year, we are on track towards delivering strong full year financial performance, consistent with the goals shared on our Q4 earnings call. We are refining our guidance today to include the expected impacts of the recent earthquakes on our Chilean Business, including items such as insurance deductibles and remediation costs.

Let’s now turn to slide four and begin or review of the first quarter results. Slide four compares results for this quarter to the first quarter of 2009. As I mentioned, revenues for the quarter were up 7% to $777 million. From a segment perspective, North American Physical posted 4% internal growth, supported by 4% storage internal growth, and strong complementary service revenue performance.

Overall gains were constrained by continued pressures on core service activity levels, including the impacts from our usually severe winter weather in several major markets. Our international physical segment reported 6% internal growth, supported by solid 8% growth in core revenues.

These gains were moderated by declines in complementary revenues, due primarily to lower project activity, and our legal segment reported revenue growth of 3% for the first quarter, including benefits from the Mimosa acquisition we completed at the end of February. Internal growth for the segment was minus 1% as eDiscovery gains were offset by impacts from lower subscription sales in the recent quarters.

Sustainable benefits from productivity initiatives and pricing gains, particularly in our North American Physical segment drove higher service gross margins supporting a 190 basis point improvement in our consolidated gross margin. Higher storage gross margins, aided by improved price in North American physical, and gains in our international physical business were also key contributor growth to gross margin improvements.

Adjusted OIBDA grew 11%, driven by strong gross profit gains. Below the adjusted OIBDA line, depreciation was $76 million, and amortization was $9 million, in line with our forecast.

Other expense for the quarter was $9 million, including $5 million of charges related to foreign currency rate changes, and a $4 million one-time charge related to the change in Iron Mountain Europe’s physical year from October 31 to December 31. This charge represents the net impact of this change for two years ended December 31, 2009. There were no other effects of this change in our P&L.

Adjusted EPS for the quarter was $0.23 per share, an increase of 19% compared to the prior year, with strong operating performance and flat year-on-your interest expense. Reported EPS for the first quarter was $0.12 per share. The reported earnings were impacted by a higher affected tax rate, reflecting the impact of discrete items, which more than offset higher pretax income.

The structural cash rate for the first quarter was 39%, as the impact of expired tax legislation was less than originally expected. The impact of discrete tax items, primarily related to foreign currency rate changes in the quarter added 23 points to the effective tax rate. We expect the structural tax rate for 2010 to be 39%. Let’s now take a closer look at our revenue growth on slide five.

Slide five breaks down our overall revenue growth. It shows internal growth by major service line, as well as the impact of acquisitions and foreign exchange. As noted, our total internal growth for the quarter was 4%. Storage internal growth was solid at 4%, while complementary service revenues rebounded from a difficult 2009, to post 17% internal growth in Q1. These gains were offset by continued pressures on core service activity levels.

Storage revenues, which represent more than 56% of total revenues, continued to provide an expanding foundation for overall revenue performance. Storage revenue internal growth was 4%, with gains moderated by economic affects with the constrained storage volume growth in the recent quarters.

Core service internal growth was flat for the first quarter. Growth rates were limited by lower activity levels, which remain pressured by economic conditions. We are planning for continued softness in core service activity given recent trends, as well as the select impacts from the service reductions related to the Chilean earthquakes.

Overall service revenues grew 5%, reflecting a strong growth in complementary service revenues, supported by recent gains and recycled paper pricing. While paper price levels remain well above 2009 levels, they recently retreated by 15% from February and March levels, which were less than future gains.

Foreign change increase reported revenue growth by 3% in the quarter reflecting the year-over-year weakening of the US dollars. The foreign exchange rates positive effects from foreign currency will moderate as we move forward. The Mimosa acquisition has minimal impacts on our revenue growth in Q1 due to the timing of the close. Looking ahead, the Mimosa issue should add just under 1% to our reported revenue growth each quarter.

Let’s now turn to slide six to review our performance on a segment basis. Slide six shows key metrics for each of our core segments compared to Q1 of 2009. As a remainder, we have distinct goals in relation to our business segments within our intergraded strategy. The North American physical segment is the key financial driver of the business, capitalizing on our core opportunities to expand our return foundation.

In the international physical segment, we are expanding our capabilities goals related to our balance of costs focused on driving strong revenue returns. In our digital segment, we are looking to drive accelerated growth in attractive incremental markets. As shown on the slide, our physical businesses continue to deliver strong operating performance.

North America, our largest segment continues to drive strong profits and cash flow. We are advancing our optimization agenda, while expanding our business foundation through a targeted growth strategy, with several programs aimed at driving improved revenue growth, and our field leadership is focused on supporting its effort with the same order they use to drive operational entrance.

Our international segment is performing well, with solid revenue growth and improved profitability. We are beginning to leverage the success we had with operational excellence in North America and our larger and more developed international markets.

Changes in the year-on- your exchange rates, increased the reported results in this segment by approximately 8%. We felt that CapEx, which was 14% of segment revenues in Q1, includes about $11 million incurred by Iron Mountain Europe in November and December of 2009.

In our digital segment, we are working through some of the effects of softer subscription revenues in recent quarters and growth, while investing to advance our long-term strategic agenda. The integration of Mimosa is progressing well, and will enhance our service offering in support of the selected digital growth.

Let’s turn to slide seven for a more detailed look at our capital spending and free cash flow. Slide seven summarizes our capital spending and our free cash flow on a year-to-date basis. Total capital spending was $57 million for Q1, including $3 million for real estate. As a I just mentioned, included in the total, $11 million of CapEx that was incurred by Iron Mountain Europe during November and December of 2009.

Traditionally the first quarter is a light CapEx quarter, as some of our projects are scheduled for later in the year and many require time to plan it’s source before the significant expenditures are eventually made. We remain focused on aggressively driving efficiencies in our capital spending, while supporting key growth initiatives in projects that help drive long-term return improvement.

For Q1, free cash flow reported acquisitions and discretionary investments in real estate as $54 million. The year-over-year decrease in free cash flow as a result of higher capital spending in 2009 compared to 2010. This grew primarily to a larger group balance at December 31, 2009, and the inclusion of the additional two months of CapEx from Europe.

For 2010, we expect free cash flow before acquisitions and discretionary investments in real estate to be approximately $340 million to $370 million, reflecting continued benefits from to our efforts to improve profitability and capital efficiency.

As we announced in our Q4 earnings call in February, our board approved a $150 million share repurchase program. In the first quarter we acquired 410,000 shares for approximately $11 million. This leaves us with a balance of $139 million for additional share repurchases under the existing plan.

Let’s now turn to slide eight for a review of our key debt statistics. Our strong performance supports the continued strengthening of our balance sheet. Our debt portfolio at March 31, 2010 remained in a very strong position. Our weighted average interest rate is 6.9% and we are 87% fixed.

Maturity is just under eight years with no meaningful repayment obligations until 2014. Consolidated leverage remained at 3.3 times, benefiting from our strong operating cash flows, while reflecting the $112 million we paid for the acquisition of Mimosa.

Our liquidity position remains strong at more than $1 billion, with $325 million in cash and $743 million in additional borrowing capacity as of quarter end. Currently we have a very strong balance sheet, and we are well positioned in terms of the cash and financing capacity.

This concludes our review of Q1 2010 results. In summary, revenue performance was in line with expectations for driving continued strong profit and cash flow performance through sustainable productivity gains, and we remain committed to strengthening our business foundation globally, while delivering strong financial performance, along track towards these goals in 2010.

Let’s now turn to slide nine to review our outlook for Q2 and the full year. Slide nine summarizes our full year 2010 and Q2 guidance. Let me begin with a discussion of our outlook for next quarter. For Q2 we are projecting revenue of $785 million to $805 million. This reflects a 5% to 8% reported growth rate, including an estimated 2% to 3% benefit from foreign exchange. While we are fighting for continued solid storage growth, our outlook incorporates expectations for lower service revenue growth in Q2.

We expect continued near term pressure on core service activity, and will be facing some difficulty comparisons as we have a large one-time license on digital, and a large project in Europe. These factors will likely limit service revenue gains overall in Q2, and constrain the overall internal growth to the 2% to 4% range. Growth rates in the second half are expected to improve as when compared to these.

We are projecting Q2 adjusted OIBDA of $218 million to $228 million, reflecting expectations for sustained strong adjusted OIBD margins. For the full year we are reinforcing the solid fundamental outlook we discussed in our last conference call. We had to use the dollar ranges of revenue by $5 million, and adjusted OIBDA by $5 million to $10 million to reflect the impacts of the Chilean earthquakes in our full year results.

As a result of the Chilean earthquakes, we experienced some damage in all of our facilities in the region. None of our facilities were destroyed by fire or impacted by water damage. However the structural integrity, 5 billion buildings was compromised and including certain buildings was damaged or destroyed. The adjustments that were made into our full year guidance reflect our expectations for loss revenues and profits, as the business works to return to normal, as well as the additional insurance and remediation costs associated with those efforts.

For the enterprise, our full year outlook for reported revenue growth remains in the range of 6% to 8%, supported by internal growth of 4% to 6%. Our revenue outlook reflects expectations for solid storage growth this year, consistent with prior guidance. We are targeting an improved growth overall in the business in the second half of 2010, following some tougher comparisons in Q1 and Q2. We would note that performance at the high-end of our revenue range will require improvement in current trends for service revenues in the second half of this year.

Our profit outlook remains stronger, and expectations were 7% to 11% growth in adjusted OIBDA, and strong gains in adjusted EPS. As noted we are lowering our expected capital expenditures for the year to approximate $290 million, reflecting refined capital plans and lower expectations for real estate spending. Included in our capital expenditure of approximately $290 million is about $20 million for real estate.

In addition, we are investing our free cash flow outlook from $340 million to $370 million, reflecting a revised outlook for CapEx and adjusted OIBDA, and moderate to higher cash taxes.

In April, we received a $10 million cash advance on our insurance claims related to the Chilean earthquakes that will be reflected in our Q2 free cash flow. Although we respect to receive additional insurance proceeds in the future, we are not including any in our cash flow forecast at this time, as the size and timing of these receipts is uncertain. We haven’t included estimates for potential incremental 2010 capital spending related to Chile as well, as it restores their operating facility planning and timing of remediation.

Thanks, and I would now like to turn the call over to Bob.

Bob Brennan

Thanks Brain, and good morning everyone. As Brain noted our quarterly financial results came in as expected. Our internal revenue growth improved somewhat, despite difficult comparisons and continued pressures from the economy and service revenues. We continued to deliver strong profit growth and cash flow. Overall, Q1 was the solid start to the year, and Ron tracked towards delivering strong financial performance this year.

Key messages that you should hear in today’s update; first our financial performance remains strong. The performance reflects the strength of our business model and the gains that we continue to drive through our focus on operational excellence across our business. We are working on improving our growth trajectory, guarding aggressively against new business with positive early results. This emphasis will help offset continued pressures on service activity and the impact on select factors such as the earthquake in Chile.

Third, we are making good progress against our strategic priorities, including driving growth and improved returns in our international business, expanding our technology services offering, and continuing to strengthen our organization. Let me start by providing an update on our growth agenda.

We are making progress on the growth front, despite some continued head wins in the business. Our quarterly growth performance was in line with expectations. Storage growth, a key financial drive for Iron Mountain was solid at 4%, as expected results and moderation in storage growth in Q1 reflecting impacts on lower new sales levels and higher destructions during 2009.

Destructions have stabilized; we are working on driving new sales and believe we are on-track towards achieving our full year objectives of storage revenues. Overall, internal growth result was 4%, as benefits from factors like higher paper pricing, offset continued pressures on core service activity. Service activity is dropping substantially during the economic downturn and we continue to see lower transportation and starting service levels, which are offsetting gains with the realigning in the areas like DMS.

We were focused on strengthening our gross trajectory as we work through the year on factors that are in our control. In this context, we’ve concentrated efforts within our organization, on capturing the large un-mended opportunities we see in our business. We have a number of programs targeting and driving improved growth, and extended our field leadership on supporting this effort with the same rigor that they used to drive operational excellence.

Of course, we are also working on improving our growth rate in digital. We’ve added new services like eVantage to address evolving customer requirements for eDiscovery services, with added classifying collect that allows our PC backup customers to easily identify it, which is subject to legal hold and we expanded the storage we could have in our server backup offerings; all of which will help strengthen our recurring storage pipeline and overall revenue.

While it’s still very early, we are making progress on the new sales front. We are landing new business opportunities in the data protection space, improved our competitiveness and strength, and our field organization is driving increased pipeline activity in records management. In digital we are strengthening our subscription sales pipeline, which will drive benefits in terms of occurring revenue gains. We’ve got work to do, but we feel positive about this early progress towards improving our new sales performance.

As we focus on improving growth trends in the near term, we are also advancing on our long-term strategic agenda. As we’re seeing in our quarterly results, we continue to drive strong operating performance in our core North American operations. The business is running well, and a key area of Iron Mountain involves extending this operating capability to drive growth and improve returns in our international operations.

As we noted, this is an area where we are driving improved momentum, and one that will be a key factor supporting strong financial performance in 2010 and beyond. We are on track of the strong performance in our international business this year, and we’ve begun deploying that North American play for operational excellence and our more detailed in international markets such as the UK and Australia.

Productivity gains in these markets will enable continued investment against global expansion, while driving strong profit gains. We are pleased with the capability and progress we are advancing on this front, and see this as an area where we can continue to build upon for the long term.

We are emphasizing the expansion of technology services, a key driver of our long-term strategy as well. As noted on our year-end call, we recently completed the acquisition of Mimosa Systems. Mimosa provides enterprise class on premise archiving services, so that we can better benefit on business continuity, compliance and litigation readiness.

Mimosa deployed its next generation technology and complements our existing suit of different products. With Mimosa, Iron Mountain now has the ability to store and applies information wherever it resides, whether it’s at the customer location or offering an increased choice and flexibility for managing our information.

The integration of Mimosa is going well, and Mimosa’s CEO, T.M. Rodney, has agreed to become the head of marketing for our digital business. This expansion of our technology services offerings helps to strengthen our digital business, and also helps to strengthen our value proposition across all our service lines.

See our customer’s records and information management challenges are not neatly arranged into silos by format. It struggling to manage the risks and costs associated with information grows across all formats, and are looking to solution providers with a broad range of expertise the capability for much needed help. Iron Mountain is uniquely positioned to capture this opportunity, as these will work across all formats and have more experience in management records.

The development of our technology services portfolio is positioning us well to deliver long-term growth across our business. We’re on the right tracks strategically as we remain focused on solving our customers biggest information management challenges. Expanding our talent base is another key strategic theme for our business. This is a focus that exists for us from our front line operations to the board of directors.

In March we welcomed Al Verrecchia, Chairman of Hasbro to our Board of Directors. Al led a highly successful of Hasbro and we’ll certainly benefit from his executive leadership on our board. Overall, we are making good progress against our strategic agenda.

Now before I conclude my remarks, I am going to mention the financial impact of the Chilean earthquake. Chilean has always been a great business for Iron Mountain, and the response to this disaster has only further distinguished their greatness. All 850 of our employees are safe. We have coordinated a worldwide effort around Iron Mountain to help them help our customers, and those round the clock efforts have also included providing humanitarian aid. We are very proud of their performance.

But before I take your questions, let me summarize. We had a solid quarter that was in line with our expectations. We are on track towards delivering strong financial performance this year. We have been concentrating our efforts around the new proven growth trajectory, while advancing our long-term strategic priorities to capture the potential we see for our business. Thanks

Now we’ll open the phone lines and take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Kevin Mcveigh - Macquarie Research.

Kevin Mcveigh - Macquarie Research

I was wondering if you could talk about the CapEx a little bit. I know we took it down to 290. As we think about that going forward, is that a new range as a percentage of revenue or just some thoughts on the CapEx.

Bob Brennan

Kevin, as you know we talked at our Investor Day about our longer-term goal in the range of 9%. We still think that that’s a good longer-term goal. We are a bit below that currently. We may see some moderate increases from the current levels overtime as storage growth improves which is our plan, but we think that that 9% level, that longer term goal is still the goal for us.

Kevin Mcveigh - Macquarie Research

Great. And could you just quantify, how much did the weather impact the core services in the first quarter?

Bob Brennan

It was a couple of million dollars. It was focused on some of the Atlantic markets and wanted to highlight it as an additional factor. It had some impact on the core services growth.

Kevin Mcveigh - Macquarie Research

Great, and then just one more and I’ll get back in the queue. The Chilean earthquake, the $10 million negative impact, what did that relate to? I know you discussed it a little bit, but can you just clarify it for me a little bit. The $10 million negative impact from the earthquakes in Chili, what did that relate to.

Bob Brennan

Yes, we highlighted two impacts; one was on revenue, which we estimate for the full year to be about $5 million, and on OIBDA a range of $5 million to $10 million. The impact on the revenue is just expectations for some decreased service activity and some loss storage revenue. Some of the records that were impacted, basically some records sold over in the facilities, and when they get co-mingled with others we destroy them, because we cant endure their integrity, and we are expecting some storage revenue.

The profit impacts, obviously there is some impact from the lawsuits. We are also factoring in things like our insurance deductibles and some steps we took to strengthen our insurance coverage, just given this was a significant event. Our clam will be sizable, we are every comfortable with our insurance coverage, but we took some conservative steps just to make sure that we have adequate coverage going forward.

Operator

Your next question comes from Andrew Steinerman – JPMorgan.

Andrew Steinerman – JPMorgan

With the 4% internal growth on storage for the first quarter, and 4% to 5% for the year, I was wondering if you think internal growth for storage is leaning forward. You you’re your comments about the second quarter overall, but do you fell like storage will stay in this kind of 4% to 5% range. In the year, if I got you correctly, I though I heard you say that the higher level of destructions have now stabilized.

Bob Brennan

Thanks correct. A couple of things Andrew; as far as next quarter we are expecting storage growth in a similar range to Q1. As we’ve noted, we are still working though some of the tougher comparisons and those comparisons should ease later this year.

In terms of some of the key factors, destructions have stabilized. So they are still at healthy levels, but the trend had been going up and we fell comfortable that things are moving in a better direction than they were. The key factor that’s going to help us on improving the storage rate over time is going to be progress on the new sales from. I think there are good results in that area and that will take some time to fall through of course, but ours are better with progress.

Brain McKeon

I’m particularly pleased Andrew with the progress that we have in generating new sales. The field leadership I mentioned just briefly in my comments has really been able to pivot and focus on driving new revenue, and we’ve got an awful lot in a pipeline that is expanding. The code of performance year-over-year is much stronger, and the fact is we’ve got the North American operations running very well. That allows us to just become much more external in our focus in driving new revenue.

Bob Brennan

I’ll also highlight our international storages is growing mid to high single digit. Based on some of the progress we made in areas like continental Europe and other expansion markets are doing quite well. So we feel we are on a good path. As you know, it takes a little time for the growth rates to change in storage, but we think we are moving this in the right direction.

Andrew Steinerman – JPMorgan

And Bob, you just mentioned new business driving storage growth to accelerate in the back half of the year, Is that always part of the plan. I mean won’t storage also accelerate as non-foreign payroll goes up.

Bob Brennan

So the flow through benefits takes some time, but the fact is we feel much better about new sales this year, than we did last year at this time.

Brain McKeon

Andrew I know you appreciate this, but I think in terms of factors like the economy, we would expect, the first things that we would see would be improvements in more discretionary spending, some of the project activity, things on the new sales front. The next benefit would be more which will lag somewhat, but we would expect service activity to improve, and I think the last thing we would expect to see is kind of the flow through of the economy.

For storage, just given that it takes some time for people to create the incremental records and to sort them, we are in a kind of storage business. So it will head back over time but I just want to caution that we are still working through some of the lag effects and we think we are prudent in terms of our outlook in that context.

To summarize, we feel very good about what we can control in driving new business, and believe that service activity will rebound as the economy rebounds. I mean you know how strong it was in 2008 as we entered the downturn.

Andrew Steinerman – JPMorgan

Excellent. Thank you very much.

Operator

Our next question comes from Andrea Wirth - Robert W. Baird.

Andrea Wirth - Robert W. Baird

I was wondering if you could just address service a little more, because I think this was the first time that it actually really hadn’t posted any growth at all. Just a little bit more on what actually kind of weakened sequentially and then how do we think about growth and how it has accelerated throughout the year?

Brain McKeon

Yes, in terms of core service, I mean we’ve been highlighting this for a couple of quarters, but the activity levels in areas like transportation services, trading services have been pressures to the premium services. Yes we saw greater pressure recently through the economic downturn; we obviously were at a high value added proposition for our customers and premium services like rush delivery levels were a significant decline and that cost focuses continued with customers.

I think, also note that in some areas we may not have been as competitive as we needed to be. We’ve been improving things like our pricing equation. I think in trading we may have stirred that a little too far; we’ve been making some adjustments on that front.

So net-net we are still seeing soft activity. We are planning for that to continue in the near term. We do expect that to improve over time, but it will lag improvement in general economic activity and we’re going to be working through those comparisons for the next couple of quarters.

Andrea Wirth - Robert W. Baird

And then on the IT side, we’ve just kind of generally been hearing comments about companies looking to increase their IT spend and kind of playing through more of the IT refreshed cycle. I think [Gardner] also recently increased their projections for IT spend. Just kind of curious what you are seeing in terms of the time line for IT expanding improvements, and you know has that really changed much recently.

Brain McKeon

So, Andreas anecdotal feedback is to spend a lot of time with customers, I don’t see IT budgets going up in any kind of significant way. What we do see is that de-capitalization of IT, which is favoring a services model and outsourced model. The thing about a subscription model is that while we were up 4% in 2009, it lags coming in and it doesn’t have a spiky effect on revenue, but we’ve had strong progress on these sales, and I feel very good about just from a macro perspective the fact that IT is going towards more of a ‘pay as you use’ model and that’s a trend that a lot of players have to adjust to more dramatically than we do, and it’s always been our business model.

Andrea Wirth - Robert W. Baird

All right, thank you.

Operator

Our next question comes from David Gold - Sidoti.

David Gold - Sidoti

Can we speak a little bit more on the record center optimization productivity improvement program? Just, again sort of how you think about things domestically? I know it's a moving target, and I know there's more to it, but sort of how far along are we on that and if we've gotten that off the ground overseas and sort of where we are there too?

Brain McKeon

We have David. It’s essentially we move from market to market and having productivity from the system we have done that very well throughout North America, and we do it from the standpoint of sustainability, so we are adding new programs as well, so we can talk to procurement initiative in the last quarter that will really focus on strengthening our gains and consistency across North America.

We have the began exporting the playbook most notable to the U.K, but also to other material markets like Australia, and we feel very good that over time we can presume North American returns out of our mature international business.

So its in the mussel memory of the company and that business is running very well while is why we are practicality enthused about the potential to grow the business through new cells because of the fact that the business is running well and we can be more external in our focus. This is something that we had to work on internally for years to get this kind of rhythm, but we feel very comfortable with where we are in that regards as it relates to record center optimization, productivity thought our business and realizing that on a sustainable bases.

David Gold - Sidoti

Is there much more in North America that you think we can squeeze out?

Brain McKeon

I think we are continuing to roll out. The process orientation, the process focus on how we manage the business, because Bob noted we are on to a kind of a net phase of initiatives in areas like procurement. We see a lot of opportunities in our organization, just how we interface with the customer and go to market.

I highlight that, we think there is efficiencies there. We do want to reinvest those efficiencies to accelerate growth. We think that’s an opportunity for us to become more effective and efficient and so we are committed to continuing to improve our profitability. We think we’ve established very good capabilities in areas like piecing and in just our process approach to running the business to enable us to keep making progress as we move forward and as an enterprise we have other areas to help us drive margin improvement.

Most notably we think there is a significant opportunity on the international business as you know the margins there relative to our business are currently quite a bit lower. There is some of that is the stage of development in that business in the investments that we are making and the expansion markets but that’s also represents the significant opportunity for us. Also the major business like gains in scales. So we have a number of things that we believe can help us sustain strong profit performance and revenuer growth as we move forward.

Bob Brennan

Lets remember the primary driver behind this, we always new that we will be able to be more effective that for produce stronger operating margins as a result of _ . the primary driver was so that we would establish the level of value in the market place that we could then drive though new sales and the value proposition that’s realty unmatched in our business,

Operator

Your next question comes from Vance Edelson - Morgan Stanley.

Vance Edelson - Morgan Stanley

First in terms of recycle paper can you comment on what you are seen on the front lines in terms of your ability to sell the paper as your volumes builds. Are you able to secure favorable pricing, can you work directly with large buyers of the commodity for example, would you say you are essentially behold into whatever the spot rate is?

Brain McKeon

We have a relationships with companies like waste management, significant partners to help us manage that and that helps us to have a secure avenue for sales overtime. Our pricing is impacted by this spot market so we do see fluctuations in the pricing levels, overtime consisting with the market. We are quiet comfortable in our ability to secure buyers for the paper.

Vance Edelson - Morgan Stanley

Okay, got it; and on the capital spending priorities going forward, would you say that will largely mirror the first quarter break out; in other words, mainly storage and maybe half that amount on IT. Any changes to the mix anticipated?

Brain McKeon

Our outlook for this year, is similar to our long range goals. The bulk of our spending is related to storage systems, that’s imported growth. So that’s physical and digital, and a smaller percentage of our spending is on things like IT and strategic initiatives and infrastructure, so the bulk of our spending remains related to growth oriented capital.

Vance Edelson - Morgan Stanley

Okay, it makes sense. And then speaking of growth orient capitals, beyond the established international markets where you still have room for growth, what’s the latest in terms of international expansion into brand new less developed markets. What regions are you really looking at to create a first time presence now?

Brain McKeon

To create our first time presence; I mean if you look where we were not, we’re still not in Japan, we’re not in Africa, we’re not in Middle East, in those areas that we are always looking for the right joint venture partners to enter the market with. We are most successful when we go in with the local partners that knows the local market. China is an area where you could argue that we have some flags planted, but there is a lot of opportunity for us to improve our presence in that region, and we recently brought on some talent that will help us to do that.

Vance Edelson - Morgan Stanley

Okay, and in the more developed markets, is there room for contiguous expansion geographically or would you say to drive revenues it's more a matter of increasing penetration and density in the geography that you already have.

Brain McKeon

I mean specifically if you look at Brazil, Russia, and India we have very good business that we are think we can -- Brazil, it’s economy to expect that’s move up the stack rank if you will in the next two years, and we think that something that we can take advantage of. Russia we have a great business in our joint venture partners and we are very pleased with the way that’s going, and remember that there is a ton of room in continental Europe as well.

You know we are still in the earlier stages of scaling these individual countries. Unlike North America, Spain is different from Germany, which is different from France and those businesses still have a lot of improvement. In a time scale that’s measured in years you will see more improvement there, than you will from markets where we are just entering.

Operator

Our next question is from John Healy - Northcoast Research.

John Healy - Northcoast Research

I want to talk a little bit about North American physical revenue growth in the quarter. I was curious if you could give us a little bit of color in terms of maybe the component of growth, kind of how much you're seeing from activity levels and creation and maybe how much you're seeing from a pricing stand point?

Brain McKeon

Just in terms of storage, it was solid, we noted it was 4%. We are getting benefits from pricing to support that, but it’s driving positive volume as well. Its obliviously moderated from what we used to, driven by some of the impact last year; the higher destruction rates and the softer new sales, but overall we’re continuing to grow solid storage revenue growth, and we are looking to improve that as we move forward.

The service activity was supported by a couple of factors. Obviously through paper pricing, we are seeing very good growth on the DMS front, and those factors are offset by the softness that we see on service activity levels and also kind of on a select basis some of the more additional project work that we have done, that is related to managing hybrid records, which we think has kind of taken a softer activity in some of the sales pipeline that we saw from last year.

On balance it’s solid growth inline with what we are hoping to achieve and we are working on other things that we think we can improve that overtime, and position us well for when we see some of the benefits of the economy improving.

John Healy - Northcoast Research

And Brian, I thought you mentioned in a prior question that the first thing you'd see is some of the discretionary parts of your business that you’re firming before other parts would. If you were to exclude the impact of recycled paper prices in the complementary service lines, would you be starting to see that kind of discretionary element of the business picking up or have you got to experience that?

Brain McKeon

We are seeing that. It was positive in the first quarter, and that was supported by DMS, also by our eDiscovery business, but that is a favorable factor. It’s moving forward sequentially. I don’t want to give you an impression it’s turned around quickly. It’s moving in the right direction, but those early indicators we are seeing some of the positive factors and just I need to be the voice of caution here, and I just want to make sure that people know it. It takes time for some of the benefits to flow through our business and we are going to be working through this in the next couple of quarters, but we do see some signs that its moving in the right direction and we are working on things that will hopefully strengthen that.

Bob Brennan

Just a fact; remember that we lag in to the downtown and we lag coming out of it. Its just the nature of our business model?

John Healy - Northcoast Research

No it's encouraging that piece is at least poking its head up a little bit. Lastly just on the shutting side of the business; I thought you mentioned you may have changed a little bit in the price and value proposition. Can you talk a little bit about maybe how that business performed excluding recycled paper prices in the quarter, and what you think a realistic growth rate for that business could be this year?

Brain McKeon

The revenues in the business were up solidly in Q1, supported by paper. It’s a little difficult to separate paper from the overall business, because as you might imagine the competitive dynamic is that flows into the overall economics and it influences how you would price your services and things of that nature.

Our service revenues were down moderately, but overall it was the quarter for shredding and we think we can have solid growth in that business this year, again aided by some of the macro factors. Bob you want to talk about some of the dynamics.

Bob Brennan

Yes, John this is narrower I think. We constructively dipped that with the way we competed last year, and we think we allowed our competition some entry and that we are being more aggressive now, and I believe we’ll see the benefits of that, because we have a value proposition that is differentiated from that of our competition, especially as it relates to the chain of custody.

We have specific programs in place that allow our sales force to really attack competition, where we gave them a little bit of room last time and we shouldn’t have done that, but we are also working through channels here, so you can expect to see announcements from some of our partners, specifically in the commercial real estate space, and some more to come on that, but where people see the usefulness of offering shredding to their customers; whether it would be an in-office space or other locations that will hope to announce later in the year.

Operator

Our next questions comes from Eric Boyer - Wells Fargo Securities.

Eric Boyer - Wells Fargo Securities

Yes I suspect that you want, but do you expect any change in seasonality patterns for total consolidated results now that the European business will have a calendar year-end?

Brain McKeon

Not from the European change. In fact, one of the conclusions as we went through this process was significant effort for the team to kind of deviate on this and get us to a place where we are fully aligned in terms of our reporting globally. The conclusion was, there wasn’t really material affect from the seasonality change, so that enables us to keep the change relatively simple and have a one time charge pull through the other expense line. So the short answer is no, there shouldn’t be an effect in that.

Eric Boyer - Wells Fargo Securities

And then with the situation like the, the winter weather that was experienced in the, in the first quarter will any of that revenue be pushed out into the second quarter or is the majority of that type of service revenue lost?

Brain McKeon

It’s hard to asses, but I wouldn’t count on that being a push out. I think that’s related to normal activity that didn’t happen and we are not expecting it to. I think the key thing on the service sides to recognizes is, which we try to highlight is; one thing is the course of this activity remains soft and we are planning for that to continue for decline in the near term. That we are against a couple of tough comparison in Q2.

We had big project in Italy last year that was very beneficial. We’ll work through the lapping on that, and get a large license on digital. So there’s a couple of factors that are going to moderate growth. Paper pricing came down 15%, so that’s less of a benefit, but net-net, I think overall in the business we feel good. We got the storage movement on a good track. We are seeing some positive sings, and we’re looking forward to getting through some of the transition phase here and get to a solid growth rate moving in 2011.

Eric Boyer - Wells Fargo Securities

And then with the subscription weakness within digital, which type of the digital subscriptions would you expect to come back first and are you seeing any positive signs that that's happening?

Brain McKeon

Yes, we are definitely see positive signs as it relates to pipelines. eDiscovery is a very strong business for us. We are very, very pleased with Mimosa and our backlog offerings have become more competitive. I mentioned it quickly in my remarks, but we’ve added capability to our backup offerings that we think opens up the market opportunity for us and we are seeing a promise out of our sales versus to driving increased activity in the pipeline. Keep in mind it’s the subscription model, so we don’t get the lumps that come positively or negatively would being a professional licensed business that you’ll find in many technology companies.

We are seeing solid growth in the subscription pipeline, so we’ll look for that to benefit our results going forward.

Operator

Your next question comes from Scott Schneeberger - Oppenheimer & Company.

Scott Schneeberger - Oppenheimer & Company

My first question actually, if you guys can give some color commentary on your industry verticals for 1Q and it possible like what you have going it like 2Q?

Brain McKeon

We don’t report granule basis, I would say that in terms of verticals we are very focused strategically in areas like healthcare and government in terms of long-terms growth rate and we are pleased with the progress that we are making on that from. Financial services is obviously a big vertical for us and we are seeing substantially different trends across our verticals, I think they are relatively consistent business…

Bob Brennan

we are on the right tack though as it relates to the kind of opportunity we fix. We see a lot of usefulness in building our organizations to really drive depth into those industries that are highly regulated with a lot of knowledge. Workers still think financial services, healthcare, legal and you can see through our service offerings that we are becoming more verticalised and you can expect that will become more verticalized in our approach to the market overtime, but we don’t expect to breakout the results specifically by quarter.

Scott Schneeberger - Oppenheimer & Company

My following question actually was, the fuel price are up year-over-year quite significantly, if you guys can just give some color on overall energy cost.

Brain McKeon

Our overall energy cost remain in the 2% to 3% range, it wasn’t a big driver of our margins one way or the other and we are just fuel charges which have been not been material in recent quarters, but we saw our consists an increase is on that prompt we have some ability to offset that with the fuel charges.

Operator

At this time there are no further question, are there closing remarks.

Brain McKeon

Thank you very much. I very much appreciate your time this morning and we feel very good about the business, we feel very good about our prospects and look forward to reporting to you again next quarter. Thanks your time today.

Operator

This concludes today's conference call. You may now disconnect.

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