Jul 30, 2009
Executives
Stephen Golden – Vice President Investor Relations Robert Brennan – President, Chief Executive Officer Brian McKeon – Executive Vice President, Chief Financial Officer
Analysts
Andrew Steinerman – J.P. Morgan David Gold – Sidoti & Company Andrea Wirth – Robert Baird Vance Edelson – Morgan Stanley Kevin McVeigh – Credit Suisse Franco Turrinelli – William Blair Scott Schneeberger – Oppenheimer
Operator
I would like to welcome everyone to the Iron Mountain second quarter 2009 earnings call and webcast. (Operator Instructions) I would now like to turn today's call over to Stephen Golden, Vice President, Investor Relations.
Stephen Golden
Thank you and welcome everyone to our 2009 second quarter earnings conference call. After my announcement this morning, Bob Brennan will give his state of the company remarks, followed by Brian McKeon who will deliver the financial review.
When Brian is finished, we'll open up the phones for Q&A. We certainly had a busy June this summer, meeting with both equity and credit investors in Chicago, L.A., London and New York.
We'd like to thank you all for taking the time to meet with us and we certainly appreciate your council and continued support. I'd also like to ask you to mark your calendars as our 12th Annual Investor Day will be held on Tuesday, October 6, 2009 in New York City.
This year we will be holding the event in the Hudson Theater in the Millennium Broadway Hotel on 44th and 45th. Stay tuned.
We'll be releasing more information as it becomes available. The best way to stay informed is to sign up for email alerts at the investor relations page of our website.
Per our custom, we have a user controlled slide presentation on the investor relations page of our website at www.ironmountain.com. Referring now to Slide 2 of that presentation, today's earnings call and slide presentation will contain a number of forward-looking statements, most notable our outlook for our 2009 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 current report on Form 8-K filed on May 8, 2009 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 you know, operating income before D&A, or OIBDA and free cash flow before acquisitions and investments among other metrics are metrics we speak to frequently and ones we believe to important in evaluating our overall financial performance. We provide additional information in the reconciliations of these non-GAAP measures to the appropriate GAAP measures as required by Reg G at the investor relations page of our website as well as in today's press release.
With that, I'd like to introduce our CEO, Bob Brennan.
Robert Brennan
Thanks Stephen. Good morning everyone.
Iron Mountain's business remains strong. We continue to deliver stolid results and we expect that we can sustain good performance going forward.
Our business is performing very well in this recession as evidenced by the fact that growth is solid and core revenues are expanding with core growth of 6% and internal growth of 4%. We will be below the aggressive targets we set heading into 2009, but we feel good about the expansion of our business and our prospects going forward as evidenced by the fact that our bottom line is very strong with OIBDA up 17% for Q2 on a constant dollar basis, and 19% for the first half on a constant dollar basis.
As Brian will explain in a few minutes, our cash flows and our balance sheet also continue to strengthen. As many of you know, our strategy is to optimize our core business while investing in growth.
This strategy is in full force as we manage to achieving our full year targets. Let me review the business by segment, beginning with our largest and best performing business, the North American physical business.
North America has been working on an agenda of pursuing growth while increasing returns since we integrated the offsite data protection and hard copy records management businesses in 2005 under Harry [Epinhausen's] leadership and they're doing a great job pursuing both growth and productivity. Let me start with the growth front.
We think about growing the business of the North American physical business through vertical segmentation and through the introduction of new services. I'll just describe a few of the key verticals.
Financial services is a very large market for us where there's obvious pressure to reduce costs, but we also have a tremendous amount of opportunity as we continue to help our customers in this sector manage through industry consolidation, litigation and the increasing amount of regulation that they face. During the quarter we actually landed two nationwide shredding deals in this space, both in the low seven figures on an annual basis.
The health care market is also an important market and a large sector for us, and this is obviously an industry that faces acute records management problems and there's a lot of attention and money going to this market. We've had a dedicated organization for some time and have a very broad service line across this function.
So whether it's active file management for a person's medical records, all the way through to the image archive that occurs in a radiology department, on an in sourced or out sourced basis, we have a lot to offer that industry as it tried to grapple with a very large problem associated with records management. From a government perspective, this is an area we've been investing for a few years with a dedicated organization and if you're doing business with the U.S.
Government today, there's a new set of rules around how you must comply with the storage and protection of information. Some of that is related to facilities, and we've already made investment in compliant facilities that are beginning to fill up where we fill very good about the potential going forward.
Retail is another segment that we actually got into as a result of entering the shredding business earlier this decade. During Q2 we actually won one of the largest retailers in the world with a nationwide shredding win that covers 2,000 locations.
This is a customer that we had won from a records management perspective years ago, and represents the opportunity for us to increase our share of wallet with that customer. That will give you a sense for how we're thinking about some of the most important verticals segments.
In terms of new services, you've heard me talk about DMS for a couple of years now and we've been building up that business. We had some key wins in North America in Q2.
The National Bank of Canada was faced with new legislation and we were able to help them with an image on demand solution for the work flow that was affected by that legislation, helping them be more compliant as well as save money. They've been a customer of our since 1996, so they knew we were very familiar with how to adjust their work flow.
Navistar is a long term customer where we have actually noticed a spike in their retrieval activity and after inquiring about that, found out it was related to a specific legal matter. We were able again to apply our image on demand capability to help them with that matter and now are helping them across the entire legal function.
I do want to be clear though, make no mistake about it. It is harder to sell these days, but our offerings are matching up well with the market needs that we see.
Our pipeline continues to expand and we remain sharply focused on growing our core business as a top priority. We are also focused on optimization of this business through improving productivity, and there's two areas I just want to briefly highlight.
One is record center optimization. This is where we take a market by market approach to improving work flow, and by focusing on improving work flow, it has the benefit of producing higher service gross margins, higher service quality and higher employee satisfaction.
We're also focused as you know on extracting value for the investments that we've made through a pricing excellence program and we continue to build systems and processes to sustain pricing for the very long term so that we can capture value for the investments we've made on a sustainable basis. So North America is doing a good job pursuing their agenda of growth and productivity.
That being said, we are seeing some pressure on the margin. Higher unemployment obviously means fewer employees which results in fewer transactions.
Lower retail sales means fewer receipts. It takes longer for our shredding bins to fill up which means less frequent bin tips.
And activity levels in general have moderated. We also apply some of our pressure ourselves.
We help our customers lower total programming costs, and sometimes that means that you'll see more destruction volume and this has a dampening effect on near term volume, but it positions us well with the account for future growth and helps us lower our customer's total program costs. But even when you take these factors into account, the North American physical business is doing a great job generating higher returns as we pursue a long term growth agenda and we expect it to sustain momentum in this business for the very long term.
So let me move on to the international segment of our business. I'm very proud of the job our senior team from our international business is doing as they manage and plan the business, and they've done a good job improving the business.
Performance in the quarter was good with internal growth improving to 6% despite the lapping effect associated with a very large project. Continental Europe is experiencing strong volume gains from the investments we've made in real estate capacity and in building out our sales force.
We landed two large seven figure DMS deals out of France and Germany in the quarter. Latin America and Asia Pacific both showed double digit internal growth rates and our JV's which is how we establish ourselves in the markets are also performing well.
One to highlight is Russia where under Tom Keller's leadership, just since 2006, we've built up five facilities, have 500,000 cubic feet of records under management for 400 customers. So international continues to improve as well.
Our playbook is to drive for higher productivity from those markets where we're most established, invest in selective geographic expansion and we expect to achieve North American returns over time. So digital; we're more than holding our own at Iron Mountain digital.
I've been in the technology business for a very long time, and this is as tough as I've seen it. Many of the best and biggest technology companies are going backwards in absolute performance.
Sales cycles are longer; deal to firming is common place. Internal growth for us in the quarter was 4%.
Not bad on a relative basis, but it's not what we targeted. The reason that we are growing in absolute terms is because it is a trends favored business.
For those of you that follow technology, you know that cloud if you will, is all the rage right now, and while it's an overused term, cloud computing essentially refers to, it's about only using the capacity you need and only paying for what you use. And if you step back, that's been Iron Mountain's business model since inception.
That's how we built the box business. That's how we built the tape business.
And that's how we built our digital storage services business. And digital had some key, key wins during the quarter.
One of the largest technology companies in the world standardized on our PC data protection solution for their entire company. AT&T continued the roll out of our data protection solutions across Europe throughout the quarter and our new products continue to launch well.
As a matter of fact, our core physical sales for is selling more digital products and is responsible for 40% of the pipeline for virtual file store, a solution that we've been introducing over the last couple of quarters that takes inactive data off of a customer's primary computer systems and storage systems and stores it in our vaults more securely and cost effectively than the customer could for themselves, cloud if you will. We continue to benefit from the explosive data growth and the brand permission that we have to protect other's information.
There is both a curse and a benefit in IT budgets being constrained, but it does favor outsourcing which favors us of course. So it remains a trend favored business where we have a unique competitive advantage, although I will tell you I expect continued pressure in the short term as it relates to selling technology.
As I said before, we're more than holding our own. So that should give you a good sense for how we're managing strong performance across North America, International and Digital.
I'm going to turn it over to Brian now, but before I do, I want you to know that we remain very well positioned to advance our growth agenda while delivering great bottom line performance. I look forward to your questions in a few minutes after Brian McKeon; our Chief Financial Officer concludes his financial commentary.
Brian McKeon
Good morning everybody. Q2 was a solid quarter for Iron Mountain.
Our results were highlighted by continued strong year on year OIBDA growth in the face of economic pressures that are moderating top line gains. Core revenues which comprised 87% of our total revenues in the quarter and are a key indicator of the health of our business, grew a solid 6% organically and offset expected weakness in our complimentary service revenues.
As expected, the year on year strengthening of the U.S. dollar against our major foreign currencies lowered both reported revenue and OIBDA growth in the quarter by approximately 7%.
The dollar did weaken materially within the quarter which resulted in gains in other income and our book tax provision. This resulted in an increased of our reported EPS of $0.18 per share.
Excluding currency impact, revenues grew 17%, reflecting benefits from our continued focus on disciplined execution across our business. Overall, our Q2 performance was in line with our expectations and builds on the solid start to the year.
We're positive about our business performance and outlook and remain on track towards delivering solid full year results. Today we will review our quarterly results and provide an update on our cash flow performance, capital spending and our current debt position.
We'll also provide additional perspective on our 2009 guidance and the refinements we've made to some of its components. Slide 4 highlights the key messages from today's review.
As noted, Iron Mountain delivered solid financial results in Q2 with performance trends similar to those we saw in the first quarter. Internal growth was sustained at 4% with overall growth constrained by an expected decline in complimentary service revenues including impacts from lower recycle paper pricing.
Core revenue internal growth, while solid at 6% in the quarter, is tracking below our target range as economic factors continue to limit core revenue gains. As Bob mentioned, service activity levels have not moderated.
Core technology services are longer to complete than usual, and destruction activity has increased as some customers implement long term cost saving initiatives. Despite these impacts, we continue to deliver very strong OIBDA performance at the high end of our forecasted range, benefiting from record center and transportation productivity initiatives, improved storage margins and disciplined cost controls.
For the quarter, we delivered solid OIBDA growth of 10% on a reported basis and 17% excluding the impacts of foreign currency rate changes. As a reminder, 3% of this growth is due to the initial re-characterization of vehicle leases as we previously discussed.
We also continue to improve our cash flows and strengthen our balance sheet. We remain on track towards delivering record cash flows this year, supported by disciplined capital spending and have maintained strong liquidity and record low leverage ratios.
The factors driving our profit and cash gains are sustainable and are keeping us on track for a strong full year performance. In terms of our outlook for 2009, we are adjusting our full year internal revenue growth guidance to reflect year to date trends while refining our OIBDA outlook positively to incorporate our strong first half performance and reflect current FX levels.
I'll speak to this in more detail later in the presentation. Let's move on now to looking at details of our revenue growth performance on Slide 5.
Slide 5 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% consistent Q1 trends. Internal growth in our core revenues was 6% for the quarter.
As noted, these revenues represent 87% of total revenues in Q2 and provide a solid foundation for our overall revenue growth. While core revenues growth remains solid, economic factors are constraining gains below the 8% to 9% growth range we targeted earlier this year.
Storage growth is being moderated by longer new sales cycles in our digital business. While physical storage rates have sustained, factors such as higher destruction rates have constrained gains below strong target growth levels.
Core service revenues which were up 5% on an internal growth basis in the quarter, have also been trending below our goals as activity based revenues have been impacted by the ongoing economic slowdown. Complimentary revenues which are the most likely to be impacted by economic conditions, declined 6% organically in the quarter.
As expected, we saw pressure in Q2 due to the completion of a major public service contract last year and from lower recycled paper revenues. These impacts were partially offset by a large license deal completed in the quarter and the continued solid performance by our stratify business.
We're planning for economic impacts to continue in the near term and have adjusted our full year internal growth outlook to reflect year to date trends. Offsetting these impacts are more favorable trends on the FX front.
For the quarter, the strengthening of the U.S. dollar against all foreign currencies over the last year, led to a 7% decrease in reported year on year revenues.
However, more recently we've seen a weakening in the U.S. dollar and based on current foreign currency rates, we expect the year over year impact of FX to be less than originally anticipated.
We're now expecting a full year negative impact of 5% rather than 7%. As a result, we expect our full year reported revenue growth to remain in the minus 3% to 0% range.
Let's now turn to Slide 6 to review our P&L performance. Slide 6 compares the results for this quarter to Q2 of 2008.
Overall, productivity gains, favorable business mix and disciplined cost controls enabled us to deliver continued strong bottom line performance. Our overall revenue performance was in line with expectations.
Our largest segment, North American physical posted 4% total internal growth. Continues solid core internal core revenue gains were offset by the decline in recycled paper prices and lower project revenues.
The weakening of the Canadian dollar reduced reported revenue growth in this segment. Our international physical business achieved 6% total internal growth, supported by strong core revenue gains in Continental Europe, Latin America and Asia.
As expected, the total internal growth rate was impacted by decreased complimentary service revenues, including impacts from the completion of a large European project in 2008. Reported growth was reduced by more that 20% due to the strengthening of the U.S.
dollar over the last year. As noted in previous calls, our international revenues and costs are aligned in local currencies and these changes don't impact the health of our business.
Finally, our digital segment posted 4% internal growth. Stratify continues to perform well and our Q2 results benefited from a major license win.
Overall digital revenue gains were constrained however, by pressure on new subscription sales. Sustainable productivity gains, particularly in our North American physical business helped drive strong year on year improvement of 320 basis points in our gross margin.
Gains were also supported by a higher storage gross margin in North American and the sale of our low margin data products business. Our gross profit and gross margin also benefited from the $5 million reduction in rent expense due to the initial re-characterization of certain vehicle operating leases to capital leases.
SG&A growth was 2% in the quarter compared to prior levels excluding the impact of FX changes. This modest growth rate reflects the benefit of overhead cost controls we've advanced.
OIBDA was $217 million for the quarter, up 10%. Included in our OIBDA for Q2 of 2009 is a $1 million asset loss compared to a gain of $1 million in Q2 of 2008.
Excluding asset gains and losses, OIBDA increased 11% on a year on year basis, including 3% of growth from the initial re-characterization of certain vehicle leases. OIBDA growth was reduced by about 7% due to the strengthening of the U.S.
dollar in Q2, 2009 compared to Q2 of last year. Depreciation was $70 million and amortization was $9 million, in line with expectations, reflecting continued capital spending controls.
D&A grew $6 million versus prior year levels in Q2, primarily reflecting the additional depreciation associated with the re-characterization of the vehicle leases. Operating income was $138 million for Q2 of 2009, up 11% versus the prior year.
Excluding asset gains and losses, operating income grew 13%. Moving on with our review of Q2 P&L performance, Slide 7 bridges our Q2 operating income to net income attributable to Iron Mountain, and EPS results.
As discussed, operating income for the quarter was up a strong 11% to $138 million on a reported basis. Our Q2 interest expense decreased compared to Q2 of 2008, driven primarily by lower debt levels and reduced interest rates.
These gains were further enhanced by positive impacts to other income and our effective tax rate from changes in FX rates since the end of Q1 which would increase net income by $36 million or $0.18 per diluted share in Q2. As a result, we reported net income attributable to Iron Mountain for the quarter of $88 million or $0.43 per diluted share.
As discussed on prior earnings calls, large fluctuations in foreign currencies during the quarter can result in meaningful accounting impacts as we mark our foreign contracts and debt to market and record the appropriate tax affects from these changes. In Q2, favorable FX changes drove $17 million of other income.
We also recorded a $19 million tax benefit on these amounts, reflecting both foreign currency gains and losses incurred in different tax jurisdictions. These impacts are one time and primarily non cash in nature.
In Q2, the impact of foreign currency rate changes reduced our effective tax rate by about 26 points. Other discrete items such as FIN48 interest, changes to tax reserves and other adjustments reduced our effective tax rate by an additional 1% in the quarter.
For the quarter, our tax rate before the impact of foreign currency rate changes and other discrete items was 41%. This was slightly higher than forecast due to a shift in income between foreign jurisdictions and higher un-benefitted losses in some of our foreign subsidiaries.
We're currently forecasting our tax rate before the impact of foreign currency rate changes and other discrete items for 2009 to be approximately 40%. Let's turn to Slide 8 to look at our year to date results.
Turning to Slide 8, you can see that our Q2 results continue the trends we saw in Q1, resulting in a very solid start to the year. Overall, we continue to drive strong operating profit performance, despite economic factors constraining revenue growth.
Internal revenue growth is consistent at 4% supported by solid core revenue internal growth of 7%, offsetting expected pressures on complimentary service revenues. We're building on these gains through a disciplined approach to deliver strong, sustainable profit results.
Productivity gains and improved pricing in North America are key factors supporting a 290 basis point improvement in gross profit. Combined with controlled overhead spending, this resulted in a 370 basis point improvement in our year to date OIBDA margin.
Net income for the first half of 2009 was $116 million compared to $69 million for the same period in 2008. The key factors impacting the 2009 results are higher operating income, and the impact of foreign currency rate changes on other income and our effective tax rate.
For the first six months of 2009, FX changes have resulted in $24 million of other income including the associated tax benefit. Combined, these factors have added $0.12 to our year to date EPS.
Adjusting both years EPS results to exclude these factors, comparable EPS has increased 45% year to date. Let's shift now to reviewing drivers of our cash flow performance.
Slide 9 summarizes our capital spending for the quarter. It highlights our year to date results compared to the full year 2008 amounts and our current 2009 outlook.
Our year to date 2009 CapEx is $116 million, including $9 million for real estate. Traditionally, the first half of the year is lighter with respect to CapEx as many of our projects are scheduled for later in the year and many require time to plan and source before the significant expenditures are eventually made.
We're currently spending to our plan and expect to finish the year on target. As a percent of revenue, this will sustain the record low performance levels achieved in 2008.
We remain focused on aggressively drive efficiencies in our capital spending while supporting key growth initiatives and projects that help drive long term return improvement. Let's now move to Slide 10 and look a free cash flow for the quarter.
Slide 10 highlights our year to date cash performance compared to the same period in 2008. For the first half of 2009, free cash flow before acquisitions and discretionary investments in real estate was $121 million.
The year on year increase in free cash flow is supported by higher OIBDA and disciplined control of capital expenditures. For 2009 we continue to expect free cash flow before acquisitions and discretionary investment in real estate to be approximately $210 million to $240 million.
This will result in a strong improvement over record 2008 levels, reflecting continued benefits from our efforts to improve profitability and capital efficiency. Now let's turn to Slide 11 to review our debt statistics.
Our focus on cash flow improvement is supporting continued strengthening of our balance sheet and liquidity. In terms of our debt portfolio, we ended the second quarter of 2009 in a very strong position.
Our weighted average interest rate is down to 6.8% and we're 81% fixed. Maturity is now 6.7 years with no meaningful repayment obligations until 2012.
Consolidated leverage at the end of Q2 remained at 3.6 times, below the low end of our target range of four to five times OIBDA and substantially below our 5.5 times covenant limit. As we've discussed in the past, our business will naturally de-lever in the absence of meaningful acquisition spending.
With limited acquisition activity over the last year, and benefits from our stronger operating cash flow, we've seen significant improvements in leverage ratios and liquidity. We currently have over $315 million in cash and $565 million in additional borrowing capacity.
We have a very strong balance sheet and we're well positioned in terms of cash and financing capacity. This concludes of our review of the Q2 2009 results.
In summary, we're positive about the results both operationally and financially. Operationally, we continue to make progress in strengthening our core North American business which is the engine for our financial performance, while expanding our international and digital growth platforms.
Financially, we delivered financial results at the high end of our target ranges in a tough environment while strengthening our balance sheet and cash flow performance. Let's now turn to Slide 12 to review our updated financial guidance for Q3 and the full year 2009.
Slide 12 summarizes our full year 2009 and Q3 outlook. We've refined our full year revenue range to $2.980 million to $3,040 million.
As noted, we lowered our internal growth forecast to 3.25% with these impacts offset by an improved outlook for FX. Our reported revenue growth guidance is in a similar range.
With respect to OIBDA, we're moving up the low end of our guidance range to $830 million reflecting our strong first half performance and recent FX exchanges. We're now targeting 10% to 14% constant currency OIBDA growth.
As a reminder, included in OIBDA for 2009 is about $20 million of reduced rental expense related to the re-characterization of our vehicle operating leases to capital leases. This adds about 3% to our 2009 OIBDA growth rate.
Offsetting the reduction of the rent expense are increases to our depreciation and interest expense and as such, there's limited impact from the exchanges to net income. As noted, we're maintaining our capital expenditure forecast at $380 million for the year including about $55 million for real estate.
For the third quarter, we're projecting revenues of $760 million to $780 million and OIBDA of $215 million to $225 million. A couple of factors to note in terms of our outlook for Q3, first our core service growth will face a tougher comparison given the peak levels of fuel surcharges we saw in Q3 of 2008.
Our OIBDA outlook also incorporates the advancement of select project spending in areas such as global procurement to help build on our progress in driving productivity gains. Turning now to Slide 13, you can see our updated expectations for the P&L below the OIBDA line for the full year 2009.
As we just discussed, our OIBDA outlook calls for performance in the $830 million to $860 million range. Our outlook for D&A is slightly higher at $320 million reflecting FX impacts and interest expense remains unchanged from our outlook shared last quarter.
As a reminder, we don't forecast other income and expense or non controlling interests, so the amounts you see are the year to date actual results. Likewise, with respect to our tax provision, we've assumed a 40% structural rate plus the actual impact of discrete items recorded in the first half of 2009.
These expectations summed together yield EPS in the range of $0.99 to $1.06 per diluted share, assuming 204 million shares outstanding. As a reminder, our first half results included impacts to other income and expense and our effective tax rate from changes in FX rates since the end of 2008 which increased net income attributable to Iron Mountain by $24 million or about $0.12 per diluted share.
Adjusting EPS for 2009 and 2008 to exclude these factors, this outlook implies comparable EPS growth of 12% to 25%. That concludes my opening remarks.
We'll now open the lines for Q&A.
Operator
(Operator Instructions) Your first question comes from Andrew Steinerman – J.P. Morgan.
Andrew Steinerman – J.P. Morgan
Obviously a very fine job on productivity gains. I want to focus in on Bob's comments that you're optimizing the core while still investing in growth in strategy is in full gear now.
Are we investing for growth right now or are we holding back on some of those investments this year which will shift investment spending into next year, or do you feel like we're doing the investments we want, we're not holding back and there's not any kind of delayed on investment intentions?
Robert Brennan
We're not bridling the investment profile for long term growth. That would be stupid.
I wouldn't do that.
Brian McKeon
We're absolutely advancing investments and I think Bob was hitting on the key themes around penetrating vertical segments, new product emphasis and we were able to at the same time drove productivity improvements so that we can manage that balance and deliver solid bottom line gains.
Robert Brennan
We are careful about prioritization. We're focused on the biggest opportunities and very small opportunities don't get as much attention, but we are very much focused on long term growth and we're not in any way bridling investment on the potential of our business.
Operator
Your next question comes from David Gold – Sidoti & Company.
David Gold – Sidoti & Company
Just wanted to drill down a little bit more on the changes in storage growth both as the years progressed and on the forecast. I think as we look at it over the last couple of quarters, we've gone from 8% to 7% to 6%, a fairly good showing in our view given what's happening over there economically speaking.
But a couple of things; one, I guess just your confidence from here that it truly hold which is what the guidance seems to imply, maybe modestly down, and then two, curious and this may be a tougher one to answer, but in our view being the first quarter was terrible economically speaking and the second quarter was a little bit better, are we seeing now a little bit of a lag or has it truly slowed a little bit in the second quarter?
Brian McKeon
In terms of our outlook, our outlook is very consistent with our current trends, so I think that in terms of your question, and obviously that's a bit below the strong growth rates that we were posting coming out of last year and that impacted how we thought about our targets for this year. But I think our outlook is very consistent with the trends that we're seeing and they're consistent with the trends we're seeing year to date.
So the pressure on productivity is level. It is something that we highlighted in our last call.
Robert Brennan
It's a tough environment for selling. It is driven by the economy.
We do see it settling down, but I don't see a lot of catalysts like a sudden resurgence either
Brian McKeon
You should know that our outlook assumes that current conditions continue. We're not projecting an improvement so we think we've got the growth rate appropriately calibrated.
We had some aggressive targets heading into this year. As you noted, we're still posting good growth but I think we felt it appropriate to calibrate to reflect current trends.
Robert Brennan
And just to give you some color on how we think about it internally, we think we're doing a really good job.
David Gold – Sidoti & Company
The improvement in margin, essentially could you give a sense of sustainability there? In other words, have we made any changes that are maybe shorter terms as things revert to growth that we might not be able to hold?
Robert Brennan
I want to bridge that back to Andrew's question. We think about this business as a team for the very long term.
We have the benefit of a resilient business and we have the benefit of a market that is expanding rapidly as a result of information growth and constrained IT budgets, and we think about the business for the very long term. So we're not doing anything to as I said before, bridle the business for short term results.
It's just not how we operate. And that's been the philosophy since we've been a public company and prior to that when Alisa and Richard talk about days gone by.
Brian McKeon
I would highlight one thing too, which is we've obviously very pleased with the results that we're seeing in areas like productivity gains and things that are supporting our performance. Those are results that followed investment.
So the programs that we talk about, transportation improvement, pricing excellence, record center optimization, CFR, those are proactive investments that we feel very good about. I did try to highlight that we're going to continue advancing investments on that front.
We're not launching a big initiative around global procurement as a company that involve some upfront investment that we think has great yield and payback over time. My sense is that the core of the question is around the things that we're doing short term in nature and not sustainable or we're managing the results, and I'd say that this is consistent with the approach we've been pursuing and highlighting.
We are going to continue to invest, be focused and prioritize. We drive benefit that enables us to keep up.
A lot of folks inside would say we scrutinize the investments very closely.
David Gold – Sidoti & Company
So the questions mostly are more about thinking about the future. For instance, presumably even if you didn't bridle back on spend; there are factors in there like let's say salary freezes that when things come back, presumably you can't hold that.
So just more trying to get a sense of how much of it is a function of the environment. Folks obviously understand salary freezes in this type of environment versus things revert to growth holding margins here.
Robert Brennan
We are very disciplined in how we manage the business. We have not frozen anybody's salary and we're being very careful about where we invest.
We're being very careful about what head count we bring on. We're being very careful about what projects get put in play.
But there's no arbitrary like everybody gets a salary cut. We're not behaving that way.
Operator
Your next question comes from Andrea Wirth – Robert Baird.
Andrea Wirth – Robert Baird
I want to go back to the guidance and make sure I understand it clearly. When you think about what you have been looking at for the year, essentially your first half revenue guidance did really come in line with expectations, so is it fair to say now we're assuming revenue growth stays essentially in line with where we're at right now for the rest of the year, but what you had been assuming is that that growth would actually get a little bit better throughout the year?
That's the difference?
Brian McKeon
Our current expectation is that our full year growth, our balance sheet growth is in line with current trends. I did highlight one factor which is in the third quarter; we're going to be up against our toughest compare on core service.
Some of the dialogue that we have, in that we had fuel surcharges that were basically our position to offset fuel costs so we get a benefit in revenue and when we have an increase in costs and when the costs come down, our revenue comes down. We'll have a tougher compare on that in Q3 in the core service line, but effectively our outlook for the balance of the year is consistent with our recent trends.
That is below where we were and that was the key news item, but we think we've got six months of experience in the current climate and we think that's appropriate given the trends that we're seeing.
Andrea Wirth – Robert Baird
I wonder if you could give us an update on scrap paper prices. It looks like they actually did improve sequentially from last quarter.
Just wondering how that's playing at all. Is it really enough to move the OIBDA line at all and is that playing any impact on that number being a little bit higher as well?
Brian McKeon
We factored in some recent improvement. It's obviously still well below where it was last year.
We were north of $200 a ton in the market and we had been trending in the $90 per ton to $100 per ton range. That's improved to about $110 very recently.
It looks like a kind of calibration of supply and demand is coming through a bit favorably. Certainly supply has come down a lot and some of the Asian demand seems to be holding up okay, so we don't anticipate, we factored in those kind of levels for the balance of the year.
We're not projecting continued improvement, so if we continue to see improvement on the at front, that could yield some benefit. But it looks a little bit better, but still well down year on year, so you'll still see those pressures in Q3.
Andrea Wirth – Robert Baird
When you look at your CapEx expectations going forward in terms of the level of spend, should we still assume that this 10.8% level when you look, you said 2010 initially, do we go below that level for 2010 or do we actually go up from there?
Brian McKeon
We'll give you an update on that, our preliminary view at I-day. Strategically we're absolutely trying to get that number down over time.
Any given year you can have some movement and we're not prepared to go into the details on that yet, but we're absolutely trying to bring that number down over time and obviously we've made a lot of progress on that the last couple of years.
Andrea Wirth – Robert Baird
I was wondering if you could give us an update on pricing, particularly North America.
Brian McKeon
We continue to sustain the solid improvements we've seen in the North American records management business and we talk about moving that up into the 3% type range and we're as Bob mentioned, we feel very good about the progress we made putting sustainable processes to achieve that improvement and build on that over time. So that is a factor that helped our storage gross margins.
It's obviously only one part of our business. When you look at other parts of our business, internationally, in digital, those are principally volume driven businesses.
We're not doing the same of pricing strategies in every part of our business, but in the North American records management business, we've sustained that good progress.
Andrea Wirth – Robert Baird
So you actually were at 3% North America records or you're still working towards that?
Brian McKeon
In the year to date range we were in the 3% range for that business. I'm a little concerned just to be open about it that we confuse people with this.
It's obviously, that's a number that incorporates price and mix. It's only one part of our business, but we've obviously highlighted that as an area of progress and we're in that same type of a range that we had talked about in our last call.
Operator
Your next question comes from Vance Edelson – Morgan Stanley.
Vance Edelson – Morgan Stanley
Within the health care vertical, how would you characterize the customers' ability to pay for services right now when hospital administrators are facing tight financials from fewer elective procedures, higher bad debts and so forth? How is that working out?
Brian McKeon
We don't see any material change in their ability to pay us, but we can help them because they're not having to outlay capital. That's where the big trend shifts to us, is that normally, if you're a mid market hospital, you have a choice to either send your patient to another hospital so you can have imaging services done because you can't afford to buy the storage, or you can turn to us and pay as you go.
So it's actually, we feel that is a very strong market for us going forward and we have a lot of untapped potential. It's a business that builds over time like all of our businesses.
It's a recurring business. But we'll continue to chip away at it, and we don't see any degradation from the receivables perspective in that segment.
Robert Brennan
It's an area of focus, not an area of concern. We're managing that well across the business.
Brian McKeon
I think Bob highlighted that. Across all customer segments the sales cycles are longer.
It's a tougher environment to try to get new business, but we're certainly seeing a lot of interest in the services we offer.
Vance Edelson – Morgan Stanley
How does the joint venture nature of the international expansion when it is a JV, how does that impact the ultimate returns that you hope to see, because you mentioned that hopefully those returns will hit the North America levels over time. Could you give us a feel for that?
Brian McKeon
I think the right way to think about it is that we have a portfolio of businesses in our international markets, and so the joint ventures are, they're in the early stages of development. This is where we're working with partners to build the flywheel for the future.
They are businesses that we anticipate investing and losing money in the early years and as those businesses mature and we buy them in over time, I know that's our strategic intent, they get on a track towards higher returns and our goals to get them to North American like levels.
Robert Brennan
I mentioned Russia. We've been pouring a lot of money into that business with our joint venture partner.
We're not making money on that, but they're doing a great job building out our footprint.
Brian McKeon
I think it is an important point. We will always have a degree of a lag in our international returns versus our North American returns because we're explicitly investing in part of that portfolio to build for the future.
But our strategy across the board is that we can build these businesses over time to North American like levels.
Operator
Your next question comes from Kevin McVeigh – Credit Suisse.
Kevin McVeigh – Credit Suisse
I wonder if you can give us an update on the government vertical and how that's been trending. I know we've been investing a fair amount there.
I wanted to get your sense about how trends are there?
Robert Brennan
Not unlike other companies, it's slow. It's steady.
There's a lot of spending going on there. We think the investments that we've made in these facilities that will allow us to offer compliant records management to anybody that does business with the government.
That market will come to us. It's hard for some of our competitors to make those same investments.
It's a lot of money in anticipation of revenue as opposed to reaction to revenue. But as people become more compliant and as the government insists on that compliance, we think the market will come to us.
But like with all of our businesses, it's a flywheel. It builds slowly, but once it has momentum, we feel very good about it.
We have a dedicated team down in D.C. that focuses on the market in co-ordination with our local teams, to focus on State and local governments.
When we think about government that we're really focused on, the United States Government for the purpose of compliant Federal record keeping and we believe we have unique competitive advantage, and they're going to see their information grow, and they're going to see the requirements associated with protecting that growth.
Kevin McVeigh – Credit Suisse
I wonder if you could spend a minute on the competitive environment. Obviously as we get deeper into this, on the storage business versus the destruction business, how competitors have been behaving.
Robert Brennan
It's very mixed and can be erratic. From a storage perspective, I think that the industry understands the way we're managing the business and is following our lead.
From a shredding perspective, that's a much or erratic business where we have to choose to decline business against certain competitors just taking the price perspective and we passed on that business. So it's really, I mentioned the large retailer where we got 2,100 locations and the two financial services firms that we won.
So we're winning very large deals. That's meant to imply that there's a bunch of little ones that people are pricing aggressively because they're faced with economic scarcity, and we're passing on that business, and focusing where we have competitive advantage relative to chain of custody, relative to our footprint and our ability to handle very large projects with customers that don't focus on the overall cost of the program and it's hard to beat us across 2,100 locations.
Operator
Your next question comes from Franco Turrinelli – William Blair.
Franco Turrinelli – William Blair
Maybe it doesn't even make sense to think about this way anymore, but when we were primarily talking about a physical business, we talk about new documents coming in from existing customers, new sales to new customers and then obviously the destruction at the back end. Maybe it doesn't make sense to think about it this way, but I was really trying to get a sense of which pieces of that equation have really changed relative to your expectations at the beginning of the year?
Brian McKeon
I think it's right to raise the question. Our business is certainly a lot more complicated in terms of the different product lines we're in, geographies, etc.
We did try to highlight within the physical business that we've sustained solid growth rates, that where we have seen a change relative to our expectations certainly in areas like destructions, as Bob mentioned, that's an area we have seen increases really much tied to the economic trends. It really was something that we saw start to increase in the fourth quarter and pick up more early this year and that's directly related to customers looking at cost controls.
Robert Brennan
And us helping them with it quite frankly.
Brian McKeon
I would say that the sales processes are not dissimilar to across the business that new sales are taking longer, and that's an additional factor with the margin. But fundamentally the business is growing and solid and it's just I think some of these factors are playing in and that's why we're updating you.
Franco Turrinelli – William Blair
Is there a meaningful change in, I think you sort of alluded to this a little bit, but maybe I can drill down a little bit. Has there been a meaningful change in the rate of document production that you've seen, really just from employment levels and overall macro activity.
You talked about it a little bit. I'm just trying to get a sense of how meaningful that is.
Brian McKeon
Just to go back, we continue to see solid growth in our business and that reflects our business base, producing more records, and the factors that are changing are more related to some of these economic impacts, principally things like disruptions and to a lesser degree new sales.
Franco Turrinelli – William Blair
Destructions, I thought destructions actually started to push up near term revenue but take away from future revenue. Am I still thinking about it the right way?
Robert Brennan
They do have some benefit in the near term. That's right.
It's something that's been building for a little bit and we're seeing some of those impacts here today.
Franco Turrinelli – William Blair
Does destruction fall in core services? Yes, right?
Robert Brennan
Yes. You see you have a lot of dynamics here.
The earlier point about the complexity of our business, there's lots of dynamics in core services. We lost two points of growth from fuel surcharges, activity levels have moderated, so it gets a little complication, the dynamic.
We're really trying to highlight as we're looking at our outlook, why our growth rates are a bit lower than we had targeted.
Operator
Your next question comes from Scott Schneeberger – Oppenheimer.
Scott Schneeberger – Oppenheimer
Could you speak a little bit to what the largest verticals are, perhaps percent of total revenue and how that's different from going back three or fourth quarters?
Robert Brennan
We don't break out the percentages but it hasn't changed materially over the last year. Financial services, health care, legal are our biggest segments.
Brian McKeon
As a group financial services is the biggest. If you put together professional services, legal, accounting, that would be in a similar range to financial services and then obviously you've got health care as kind of next on the list in terms of just size.
But they're all meaningful large verticals. We basically do records management across everything.
Robert Brennan
When I called out the segments, government is still small for us and we see a lot of opportunity going forward. It's going to take time to build that business, but the others are very meaningful businesses for us.
And we haven't seen a lot of movement in the percentage over the last four quarters.
Scott Schneeberger – Oppenheimer
You mentioned when you're speaking on financial services, about litigation activity, regulation activity. Is that something that you're seeing here and now or is that something you're seeing building and think is an opportunity
Robert Brennan
Both. We're benefiting from the litigation that's occurring between counter-parties on sub-prime, the consolidation with companies acquiring one another within the sector and how we can help them through that and we see more of that going forward.
Scott Schneeberger – Oppenheimer
In digital, how is the competitive landscape. You mentioned sales cycles extending.
What are you seeing more specifically there?
Robert Brennan
Just look at the public comps, right. They're going backwards.
So it's a very brutal environment for selling technology. I'm pleased actually with the growth.
It wasn't what we expected, but the fact that our business expanded and it's because, again it goes back to the overall Iron Mountain Value proposition. Everything that we offer as a service is meant to reduce cost.
So it allows us to keep people at the table. But if you're selling technology that's in any way nice to have, it's very tough out there.
When I talk about companies that are going backwards, we're talking about some of the best companies in the technology industry that have sterling reputations. So we feel we're very much holding our own, but it's a tough, tough environment.
Scott Schneeberger – Oppenheimer
So pricing is tough as well I would assume.
Robert Brennan
It's very difficult to get people to pull the trigger on purchasing. Price negotiations are tough, but it's more getting them to move on buying, and so the sales cycles are taking longer.
The pipelines are doing great. The top of the funnel is doing great.
It's getting people through the funnel. I think if you listen to the commentary from some of the biggest names in the business they can offer very granular detail on that.
We have the benefit of being a recurring business so we don't have to push the rock up the hill to the same extent.
Scott Schneeberger – Oppenheimer
On your cost management and productivity initiatives, I now it's ongoing and persistent, would you say that the low hanging fruit is captured? What inning are we in of those initiatives and if you could take us a level deeper there.
Brian McKeon
I would say we're, the inning reference is always a great one. We still see a lot of room here.
I think a good way to think about it is, we're moving to different phases of opportunity so I know that procurement as kind of a next phase. It's an area we have a level of co-ordination but I think we can do a lot better.
So we think there's a lot of fruit left to pick.
Robert Brennan
We try to hold to our one hour limit so we're going to wrap up the Q&A now. Thank you all for your time and attention this morning.
We very much appreciate you listening to us and your support.