UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
| x | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended December 31, 2006
or
| ¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission file number: 333-118754
Language Line Holdings, Inc.
(Exact name of registrant as specified in its charter)
| Delaware | 20-0997806 | |
| (State or other jurisdiction of incorporation or organization) | (IRS Employer Identification Number) |
One Lower Ragsdale Drive
Monterey, California 93940
(Address, including zip code, of registrant’s principal executive offices)
(877) 886-3885
(Registrant’s telephone number, including area code)
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ¨ No x
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
¨ Large accelerated filer ¨ Accelerated filer x Non-accelerated filer
Indicate by check mark if the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
As of December 31, 2006, there were 1,000 shares of the registrant’s common stock, $.01 par value, which is the only class of common stock of the registrant. There is no market for the registrant’s common stock, all of which is held by Language Line Holdings, LLC.
Documents Incorporated by Reference
None
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FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K contains statements that involve expectations, plans or intentions (such as those relating to future business or financial results, new features or services, or management strategies). These statements are “forward-looking” statements within the meaning of the Private Securities Litigation Reform Act of 1995 and are subject to risks and uncertainties, so actual results may vary materially. You can identify these forward-looking statements by words such as “may,” “will,” “should,” “expect,” “anticipate,” “believe,” “estimate,” “intend,” “plan” and other similar expressions. You should consider our forward-looking statements in light of the risks and uncertainties that could cause Language Line Holdings, Inc.’s (the “Company”) actual results to differ materially from those which are management’s current expectations or forecasts. These risks and uncertainties include, but are not limited to, industry based factors such as the level of competition in the outsourced over-the-phone interpretation services market, continued demand from the primary industries the Company serves, the availability of telephone services, as well as factors more specific to the Company such as restrictions imposed by the Company’s debt including financial covenants and limitations on the Company’s ability to incur additional indebtedness, the Company’s future capital requirements, and risk associated with economic conditions generally. See “Item 1A – Risk Factors” for further discussion. We assume no obligation to update any forward-looking statements.
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History
Language Line Holdings, Inc. (the “Predecessor”) was a Delaware corporation formed in December 1999 as a holding company for Language Line, LLC (“LLC”) and its subsidiaries. LLC was incorporated during February 1999 as a Delaware limited liability company. The Predecessor was acquired on June 11, 2004 by Language Line, Inc. (“LLI”) in a transaction accounted for under the purchase method of accounting (the “Merger”). LLI, a wholly-owned subsidiary of Language Line Acquisition, Inc., is a Delaware corporation formed in April 2004. LLI had no significant operations prior to the acquisition of Predecessor. Subsequent to the Merger, Language Line Acquisition, Inc., an indirect wholly-owned subsidiary of Language Line Holdings, LLC, was renamed Language Line Holdings, Inc. (“LLHI”, “we”, “Successor”, or the “Company”). The Company is incorporated under the laws of the State of Delaware.
The Merger, Escrow Settlement and Financing Transactions
On June 11, 2004, LLI, an indirect subsidiary of ABRY Partners (“ABRY”) acquired the Predecessor in a transaction accounted for under the purchase method of accounting (the “Merger”). The aggregate purchase price was $718.1 million. The merger agreement contains customary representations and warranties and covenants. At closing, $30.0 million of the Merger consideration was deposited into an escrow account on behalf of the stockholders and optionholders of the Predecessor to secure their potential indemnity obligations to LLI and payment of any post-closing adjustment to the Merger consideration to LLI. Since the Merger, periodic payments from the escrow account have been paid to the stockholders and optionholders of the Predecessor according to a pre-determined payment schedule. Final settlement of the escrow account was reached with the previous owners on July 25, 2006. In final settlement of the escrow account, the Company received $795,000 for potential tax liabilities. As the Company had already recorded these additional tax liabilities subsequent to the Merger and concluded there is not a clear and direct link to the original purchase price, the settlement amount of $795,000 was recorded as other income in the third quarter of 2006.
Concurrently with the Merger, we consummated certain related financing transactions, including the issuance of approximately $109.0 million of 141/8% senior discount notes due 2013, by LLHI, the issuance by LLI of $165.0 million aggregate principal amount at maturity of 111/8% senior subordinated notes due 2012 (the “Notes”) and the entrance into senior credit facilities in the amount of $325.0 million by LLI.
Company Overview
We are a global provider of over-the-phone interpretation (“OPI”) services from English into more than 150 different languages, 24 hours a day, seven days a week. Our specially-trained, proprietary base of interpreters perform value-added OPI services which facilitate critical business transactions and delivery of emergency and government services between our customers and limited English proficiency (“LEP”) speakers throughout the world. In 2006, we helped more than 24 million people communicate across linguistic and cultural barriers. We offer our customers a high-quality, cost-effective alternative to staffing in-house multilingual employees or using face-to-face interpretation. Through our OPI services, we improve our customers’ revenue potential, customer service and competitiveness by enhancing their ability to effectively serve the growing population of current and prospective LEP speakers.
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Products and Services
We offer three categories of over-the-phone interpretation services: (i) subscribed interpretation, designed for business customers with frequent interpretation needs; (ii) membership interpretation, designed for business customers with infrequent interpretation needs; and (iii) personal interpretation, designed for individuals who require infrequent interpretation services. Subscribed interpretation accounted for 99% of our 2004, 2005, and 2006 revenues, whereas membership interpretation, personal interpretation and document translation accounted for the remainder. Usage for the majority of customers is billed in one-minute increments. Price per billed minute is typically based on the language requested and time of day, subject to discounts related to billed minute volume pricing arrangements with certain customers.
We have recently expanded our offerings to provide customers with value-added services, such as a bundled offering with AT&T and other long distance carriers, and OPI conference phones. The infrastructure currently in place for our services affords us the opportunity to expand our product offerings into a variety of closely-related services, such as Over-the-Video Interpretation, American Sign Language, consultative analysis of ethnic marketing opportunities and document translation.
We offer our customers a wide range of applications across a variety of industries. For example, our insurance industry customers use our services to process claims more quickly, improve claim investigations, evaluate borderline claims, enhance help desk service and explain benefits. We assist healthcare customers by facilitating emergency room and critical care situations, accelerating triage and medical advice, simplifying patient admission processes, improving billing and increasing collections. Our customers in the financial services sector use our services to resolve credit card problems, increase collections, open new accounts, provide home buyer education and produce credit reports. Call centers use our services to enhance customer service centers, support personnel, facilitate billing, support multicultural marketing and bolster direct mail and telemarketing efforts.
We offer OPI services to our customers in over 150 different languages. Our top 10 languages accounted for over 90% of our billed minutes in 2006, with Spanish-language OPI accounting for approximately 72% of our total billed minutes in 2006.
Customers
Four industries: insurance, financial services, healthcare and government, accounted for 72% of our revenues in 2006, and collectively, these industries have demonstrated a compound annual growth rate in billed minutes of over 17% from 2001 to 2006. In 2006, the health care industry accounted for 31% of our revenues, the financial industry accounted for 18%, and our largest customer accounted for approximately 3% of our revenues, while our largest 100 customers represented 53% of our revenues.
Interpreters
We have assembled and organized our interpreters to deliver superior service quality in a cost-effective manner. As of December 31, 2006, we managed a total of 2,579 interpreters, composed of 485 full-time interpreters, 1,723 agency interpreters and 371 independent contractor interpreters. Full-time interpreters and agency interpreters are typically scheduled and generally handle our high-volume languages; receive extensive, company-designed training; and are supplemented by independent contractors for peak call volumes and for lower-volume languages. The current average tenure of our full-time, agency and independent contractor interpreters is approximately 5, 4 and 3 years, respectively. The majority of our interpreters work from home in the United States, with an increasing number of interpreters located in global interpretation centers.
We employ a rigorous qualification and testing program for our interpreters, with only very highly skilled applicants being selected for hire. A majority of our interpreters have significant interpretation experience, advanced educational degrees and many are native speakers of their target language. We continually train and test all of our employees and agency interpreters in their interpretation skills. In addition, we employ industry experts to develop industry-specific training programs for our employee and agency interpreters, including initial and ongoing specialized training in medical, insurance and finance terminology, as well as police, emergency and 911 procedures. As a result, we believe that our interpreters complete calls more quickly and more accurately than the industry average.
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Technical Overview
We and the Predecessor have made significant capital investments in proprietary technology over the past six years to create more efficient processes, provide business continuity and systems redundancy, allow more stability in the systems and make available a scalable technology platform for future expansion.
Our proprietary call routing system enables us to efficiently handle significantly more call volume than our outsourced OPI competitors. Our proprietary call-handling system, Telephone Interpretation Technology and Networking (“TITAN”), allows us to efficiently handle hundreds of simultaneous calls. This allows us to quickly connect our interpreters to our customers.
We rely upon a fully integrated scheduling program, Prime Time Enterprise (“PTE”), that generates monthly forecasts of volume by language against planned interpreter attendance to produce a schedule for the following month. PTE also captures historical transaction records (e.g., hours worked by interpreter) from the database servers and provides linkage to the payroll system. PTE has been modified by us to incorporate over ten years of historical call volume data in fifteen minute increments and analyze patterns of total call volume, language usage, industry distribution and customer distribution in order to optimize the time our interpreters are occupied. PTE enables us to forecast and optimize interpreter occupancy for twelve months into the future.
Our systems are comprised of multiple Avaya MultiVantage Private Branch Exchanges (“PBXs”), conversant systems and computer-telephony (“CTI”) servers. We also utilize multiple database servers. We maintain multiple systems and servers in order to provide valuable redundancy in the event of an interruption in service.
Sales and Marketing
We have expanded our sales and marketing team professionals who have been trained to serve current customers and target new customer accounts throughout the United States. Our professionals have detailed customer and industry analysis at their disposal. In the United States, we will pursue significant revenue opportunities from new accounts within our targeted industry segments. We also continue pursuing geographical diversification opportunities in the United Kingdom, Canada and Asia. The Company operates as a single segment.
We have deployed sales and marketing resources in the United Kingdom and Canada, and have begun to demonstrate our ability to leverage our United States infrastructure to penetrate these two markets. Similar to our United States strategy, we will penetrate established industry segments by increasing our presence with current customers and acquiring new high-value OPI customers in our target industries. We plan to utilize our cost advantages, industry experience and increase the interpreter pool to provide the best product and competitive pricing in these markets.
Competition
We believe that we are the leading outsourced OPI provider in the U.S. with greater scale, scope, expertise and technical capabilities than our other outsourced OPI competitors.
We believe that our most significant United States competitors include Network Omni (Thousand Oaks, CA), Tele-Interpreters (Glendale, CA), Lionbridge Technologies, Inc. (Waltham, MA) and Pacific Interpreters (Portland, OR). We believe that our largest competitor in the United Kingdom is Lionbridge Technologies, Inc., and we believe that our largest competitor in Canada is CanTalk.
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Based on our competitive assessment, we believe on one or more of the following attributes: connection speeds, reliability, breadth of languages and quality of interpreters that our performance compared to the performance of our competitors is more desirable to our customers. We believe these service attributes are key considerations in the purchase decisions for our customers. This is particularly true for organizations concerned with compliance with Title VI of the Civil Rights Act of 1964 which requires companies to have interpretation services for LEP speakers in order to qualify for federal funding.
The primary alternatives to OPI include:
| • | Customer-provided language service through bilingual agents (“in-house”) and face-to-face interpreters; |
| • | Customer relationship management (“CRM”) providers with foreign language capabilities; and |
| • | Technology such as web self-service, interactive voice response (“IVR”) units and machine translation. |
When deciding whether to use a language alternative to OPI, we believe our customers’ primary selection criteria are levels of customer service, the critical nature of a call (e.g., emergency 911 or hospital emergency room) and the cost to service the transaction.
Customer-Provided Language Service
While in-house bilingual agents can potentially offer better customer service at a lower cost than OPI service, these benefits are often not realized due to inefficiencies resulting from the need to manage internal productivity levels. Moreover, managing these agents can be a significant distraction in light of the relative minor usage by the LEP client base. As for service quality, customers are typically inexperienced in recruiting, testing, training and managing an ethnically diverse workforce and often lack the resources to service customers in more than 150 languages, 24 hours a day, seven days a week. Face-to-face interpreters can deliver more personal service, although interpreters represent a fixed cost that may become expensive if not managed efficiently. Moreover, face-to-face interpreters generally are not available on demand when needed and cannot assist in call center applications.
CRM Providers
Many third party CRM providers offer language solutions as part of their larger outsourcing offering. Generally, the number of languages offered are limited (in many cases, only one). These offerings are usually focused on program-specific, scripted sales offers and lack the flexibility OPI provides to customer service and other critical applications. Many companies choose not to outsource critical customer relationships to third party CRM providers.
Technology
Web and IVR technology provide low cost language alternatives, although the use of these technologies currently is limited to simple transactions and lacks the flexibility OPI provides for typical customer service and other critical applications. Moreover, customers still need to provide a “zero out” option when LEP speakers cannot continue with menus provided or require additional assistance beyond the basic applications. Machine translation has evolved to handle simple transactions with accuracy in the range of 80% to 90%. Similar to CRM providers and IVR technology, machine translation lacks the flexibility desired by customers for interactions with their own customers.
Legislation
Several measures have been introduced in Congress aimed at discouraging the transfer of U.S. jobs to foreign countries including a bill that would deny federal contracts to companies with offshore operations and a bill that would require notification of workers when companies plan to outsource and require the Department of Labor to compile statistics on the trend. These legislative proposals are being challenged in state court. It is not clear whether these or similar legislative proposals will eventually become law and what, if any, impact they would have on our business and operations.
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Employee and Labor Relations
Full-time employees are classified as those who are remunerated on a salaried or an hourly basis, and receive corporate benefits from us. Agency employees are also paid on an hourly basis, but are employed by a staffing agency and are eligible for benefits from the staffing agency. Independent contractors are defined as those interpreters that are paid by the minute of interpretation and do not receive any corporate benefits or direction from us. Full-time employee and agency employee interpreters are scheduled and generally handle our high-volume languages, receive training and are supplemented by independent contractor interpreters for peak volumes and for lower-volume languages. The majority of our interpreters work from home in the United States, with an increasing number of interpreters located in global interpretation centers which are mainly located in Central America. Our employees are non-unionized.
As of December 31, 2006, we employed or contracted for 2,750 workers as follows:
Function | Full-Time Employees | Agency Employees | Independent Contractors | Total | ||||
Interpreters | 485 | 1,723 | 371 | 2,579 | ||||
Operations | 49 | 6 | — | 55 | ||||
Sales & Marketing | 46 | 9 | — | 55 | ||||
Customer Care | 15 | 5 | — | 20 | ||||
Information Technology | 20 | — | 1 | 21 | ||||
Finance | 11 | — | — | 11 | ||||
Administrative | 8 | 1 | — | 9 | ||||
Total | 634 | 1,744 | 372 | 2,750 | ||||
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| ITEM 1A: | RISK FACTORS |
You should carefully consider the following factors, in addition to the other information in this Annual Report on Form 10-K, in evaluating our Company and our business.
If we are unable to successfully implement our business strategy, our business, financial condition and results of operations could be adversely affected.
The implementation of our business strategy will place significant demands on our senior management and operational, financial and marketing resources. The successful implementation of our business strategy involves the following principal risks which could materially adversely affect our business, financial condition and results of operations:
| • | the operation of our business may place significant or unachievable demands on our management team; |
| • | we may be unable to increase our penetration of the OPI market at average rates per billed minute of service which are acceptable to us; |
| • | we may be unable to continue to achieve cost reductions on a per billed minute basis consistent with our low-cost provider strategy; and |
| • | we may be unable to recruit a sufficient number of qualified interpreters. |
Our continued success depends on continued demand from the primary industries we serve.
Our success depends upon continued demand for our services from our customers within the industries we serve. A significant downturn in the insurance, healthcare, financial services or government industries, which together accounted for a majority of our net revenues in 2006, or a trend in any of these industries to reduce or eliminate their use of OPI services may negatively impact our results of operations.
Our continued success depends on our customers’ trend toward outsourcing OPI services.
Our business depends on the continued need for outsourced OPI services as driven by general economic and public policy factors. These trends may not continue, as businesses and organizations may either elect to perform OPI services in-house or discontinue OPI services, both of which would have a negative effect on our revenues. Additionally, Spanish-English interpretation services accounted for the majority of our total OPI billed minutes in 2006. A decision by our customers to conduct an increasing amount of OPI services in-house, especially for the rapidly growing Spanish-speaking community, could have an adverse effect on our business, financial condition and results of operations.
The OPI services market in which we compete is highly competitive and our failure to compete effectively could erode our market share.
Our failure to compete effectively in the outsourced OPI services market that we serve could erode our market share and negatively impact our ability to service the notes. We expect that our existing competitors will strive to improve their outsourced OPI services and introduce new services with competitive price and customer service characteristics. From time to time we may lose customers as a result of competition. Certain of our potential competitors may attempt to leverage their existing infrastructure to compete with us. For example, a large call center company may have the requisite scale to enter into the OPI services market. If this were to occur, the outsourced OPI industry may become more competitive and may force us to decrease our profit margins in order to maintain our market position.
Our average revenue per minute has been declining for the past five years.
Over the past five years, we have undertaken a strategy to manage pricing per billed minute as a strategic tool to encourage our customers to purchase more billed minutes and to optimize our market share. In furtherance of this
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strategy, we have decreased the per minute cost that we charge our customers, resulting in decreased average revenue per billed minute. If we are unable to attract sufficient volume to offset lower per minute charges or if average rates per billed minute decrease beyond our expectations, we may be unable to generate revenue growth or maintain current revenue levels in the future.
Our business could be adversely affected by a variety of factors related to doing business internationally.
We currently conduct operations internationally, and we anticipate that operations outside the United States may represent an increasing portion of our total operations in the future. Although our OPI services constitute generally accepted business practices in the United States, such practices may not be accepted in certain international markets. To the extent there is consumer, business or government resistance to the use of OPI services in international markets we target, our international growth prospects could be affected. In addition, our international operations are subject to numerous inherent challenges and risks, including the difficulties associated with operating in multilingual and multicultural environments, varying and potentially burdensome regulatory requirements, fluctuations in currency exchange rates, political and economic conditions in various jurisdictions, tariffs and other trade barriers, longer accounts receivable collection cycles, barriers to the repatriation of earnings and potentially adverse tax consequences. Moreover, expansion into new geographic regions will require considerable management and financial resources and, as a result, may negatively impact our results of operations.
Our continued success depends on our ability to attract and retain qualified personnel.
Our business is labor intensive and places significant importance on our ability to recruit and retain a qualified base of interpreters and technical and professional personnel. We continuously recruit and train replacement personnel as a result of our changing and expanding work force. A higher turnover rate among our personnel would increase our hiring and training costs and decrease operating efficiencies and productivity. We may not be successful in attracting and retaining the personnel that we require to conduct our operations successfully.
Our continued success depends on our ability to retain senior management.
Our success is largely dependent upon the efforts, direction, and guidance of our senior management. Our continued growth and success also depends in part on our ability to attract and retain qualified managers and on the ability of our executive officers and key employees to manage our operations successfully. The loss of Dennis Dracup, Chief Executive Officer, or Jeffrey Grace, Chief Financial Officer, or our inability to attract, retain or replace key management personnel in the future could have a material adverse effect on our business.
Our business is highly dependent on the availability of telephone service.
Our business is highly dependent upon telephone service provided by various local and long distance telephone companies. Any significant disruption in telephone service could adversely affect our business. Additionally, limitations on the ability of telephone companies to provide us with increased capacity in the future could adversely affect our growth prospects. Rate increases imposed by these telephone companies would have the effect of increasing our operating expenses. In addition, our operation of global interpretation centers causes us to rely on the availability of telephone service outside the United States. Any significant disruption in telephone service in the countries where we operate global interpretation centers could adversely affect our business.
Our business could be adversely affected by an emergency interruption of our operations.
Our operations are dependent upon our ability to protect our OPI interpretation centers against damage that may be caused by fire, power failure, telecommunications failures, unauthorized intrusion, computer viruses and other emergencies. We have taken precautions to protect ourselves and our customers from events that could interrupt delivery of our services. These precautions include fire protection and physical security systems, rerouting of telephone calls to one or more of our other OPI interpretation centers in the event of an emergency, backup power generators and a disaster recovery plan. We also maintain business interruption insurance in amounts that we consider adequate. Notwithstanding such precautions, a fire, natural disaster, human error, equipment malfunction or inadequacy, or other event could result in a prolonged interruption in our ability to provide support services to our customers.
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We cannot predict the outcome of various measures in Congress aimed at limiting the transfer of U.S. jobs overseas.
An increasing number of our interpreters are located in global interpretation centers outside of the United States. Although hourly wages for our off-shore interpreters are often above the average wage rate in their respective countries, these off-shore interpreters are paid less than comparable U.S.-based interpreters, and the global interpretation centers have a meaningful cost advantage over our domestic interpretation centers. Several measures have been introduced in Congress aimed at prohibiting, or at least limiting, the transfer of U.S. jobs to foreign countries. It is not clear whether these legislative proposals will eventually become law or what impact they may have on our business.
ITEM 1B: UNRESOLVED STAFF COMMENTS
Not applicable.
* * *
Together with our subsidiaries, we presently operate the following facilities:
Location | Purpose | Sq Ft | Lease/Own | Expiration | ||||
Monterey, CA | Headquarters and Interpretation Center | 28,020 | Leased | December 2010 | ||||
Elk Grove, Illinois | Interpretation Center | 5,026 | Leased | November 2011 | ||||
Dominican Republic | Interpretation Center | 16,527 | Leased | October 2009 | ||||
Panama (2 leases) | Interpretation Center | 10,076/12,273 | Leased | November 2011 and April 2008 | ||||
Costa Rica (2 leases) | Interpretation Center | 11,153/11,190 | Leased | April 2007 and 2008 |
The Company believes its facilities are adequate for its current and reasonably anticipated future needs.
We are party to various lawsuits arising in the normal course of business. While the amount of liability that may result from these matters cannot be determined, we believe the ultimate liability will not materially affect our financial position or results of operations.
ITEM 4:SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
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ITEM 5: MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Not applicable.
ITEM 6:SELECTED CONSOLIDATED FINANCIAL DATA
The selected historical consolidated financial data presented below should be read in conjunction with “Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Company’s and the Predecessor’s audited consolidated financial statements in conjunction with “Item 15 – Exhibits and Financial Statement Schedules” and accompanying notes thereto included elsewhere in this Annual Report on Form 10-K. Historical operating results in the following table are not necessarily indicative of the results of operations to be expected in the future.
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Selected Consolidated Financial Data
| Predecessor | ||||||||||||||||||||||||
| Years Ended December 31, | June 12 to December 31, 2004 | January 1 to June 11, 2004 | Years Ended December 31, | |||||||||||||||||||||
| 2006 | 2005 | 2003 | 2002 | |||||||||||||||||||||
Statement of Operations Data: | ||||||||||||||||||||||||
Revenues | $ | 163,294 | $ | 144,878 | $ | 80,284 | $ | 64,692 | $ | 140,641 | $ | 133,318 | ||||||||||||
Costs of services | 57,832 | 49,275 | 25,973 | 21,512 | 47,928 | 49,133 | ||||||||||||||||||
Other expenses: | ||||||||||||||||||||||||
Selling, general and administrative (4) | 28,891 | 24,635 | 12,441 | 10,423 | 24,221 | 20,896 | ||||||||||||||||||
Interest | 54,161 | 50,117 | 25,685 | 6,031 | 12,025 | 20,168 | ||||||||||||||||||
Merger related expenses | — | — | 104 | 9,848 | — | — | ||||||||||||||||||
Depreciation and amortization | 36,409 | 39,217 | 21,709 | 1,735 | 3,612 | 2,787 | ||||||||||||||||||
Total other expenses | 119,461 | 113,969 | 59,939 | 28,037 | 39,858 | 43,851 | ||||||||||||||||||
Other income: | ||||||||||||||||||||||||
Interest | 798 | 285 | 287 | 49 | — | — | ||||||||||||||||||
Escrow settlement (3) | 795 | — | — | — | — | — | ||||||||||||||||||
Total other income | 1,593 | 285 | 287 | 49 | — | — | ||||||||||||||||||
Income (loss) before taxes on income | (12,406 | ) | (18,081 | ) | (5,341 | ) | 15,192 | 52,855 | 40,334 | |||||||||||||||
Taxes (benefit) on income (loss) | (2,895 | ) | (8,465 | ) | (1,614 | ) | 5,968 | 20,467 | 15,415 | |||||||||||||||
Net income (loss) | $ | (9,511 | ) | $ | (9,616 | ) | $ | (3,727 | ) | $ | 9,224 | $ | 32,388 | $ | 24,919 | |||||||||
Other Financial Data: | ||||||||||||||||||||||||
Ratio of earnings to fixed charges (1) (2) | 1.97 | x | 5.30 | x | 2.97 | x | ||||||||||||||||||
Balance Sheet Data at end of period: | ||||||||||||||||||||||||
Cash and cash equivalents | $ | 20,236 | $ | 13,991 | $ | 12,164 | $ | 11,475 | $ | 4,571 | $ | 4,930 | ||||||||||||
Total assets | 843,966 | 869,731 | 904,688 | 263,566 | 263,425 | 262,278 | ||||||||||||||||||
Total long-term debt (5) | 476,097 | 484,380 | 499,644 | 224,890 | 239,081 | 202,727 | ||||||||||||||||||
Stockholders’ equity (deficit) | 204,283 | 213,420 | 222,770 | 8,740 | (6,578 | ) | 31,161 | |||||||||||||||||
| (1) | For purposes of calculating the ratio of earnings to fixed charges, earnings represent income (loss) before income taxes plus fixed charges. Fixed charges consist of interest expense, deferred financing costs written off (included in Merger related expenses) and one-third of operating rental expense which management believes is representative of the interest component of rent expense. |
| (2) | For the period from June 12, 2004 to December 31, 2004 and for the years ended December 31, 2005 and 2006, respectively, the ratio of earnings to fixed charges was less than one because of net losses. |
| (3) | On June 11, 2004 as part of the Merger, $30.0 million of the Merger consideration was deposited into an escrow account on behalf of the stockholders and optionholders of the Predecessor to secure their potential indemnity obligations to LLI. Since the Merger, periodic payments from the escrow account have been paid to the stockholders and optionholders of the Predecessor according to a pre-determined payment schedule. Final settlement of the excrow account was reached with the previous owners on July 25, 2006. In final settlement of the escrow account, the Company received $795,000 for potential tax liabilities. As the Company had already recorded these additional tax liabilities subsequent to the Merger and concluded there is not a clear and direct link to the original purchase price, the settlement amount of $795,000 was recorded into other income in the third quarter of 2006. |
| (4) | Effective January 1, 2006, the Company adopted the provisions of Financial Accounting Standards Board Statement of Financial Accounting Standard (“SFAS”) No. 123( R), “Share-Based Payment,”, which establishes the accounting for employee stock-based awards. The Company adopted SFAS No. 123( R) and as a result, periods prior to January 1, 2006 have not been restated. The Company recognized stock-based compensation of $0.4 million for grants of its Holdings Class C restricted stock units in Selling, General and Administrative for 2006, consistent with compensation recorded for all employees who had previously received grants since the Merger date. See further discussion in Note 7, “Stock-Based Compensation” in our “Consolidated Financial Statements.” |
| (5) | Note that total long-term debt includes the current portion of long-term debt. |
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ITEM 7: MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion of our financial condition and results of operations should be read in conjunction with the “Selected Consolidated Financial Data,” and the consolidated financial statements and the related notes thereto included elsewhere in this document. This discussion contains forward-looking statements about our markets, the demand for our products and services and our future results. We based these statements on assumptions that we consider reasonable. Actual results may differ materially from those suggested by our forward-looking statements for various reasons including those discussed in the “Risk Factors” and “Forward-Looking Statements” sections of this Annual Report on Form 10-K.
Introduction
We believe we are the leading global provider of OPI services from English into more than 150 different languages, 24 hours a day, seven days a week. Our specially-trained, proprietary base of interpreters perform value-added OPI services which facilitate critical business transactions and delivery of emergency and government services between our customers and LEP speakers throughout the world. In 2006, we helped more than 24 million people communicate across linguistic and cultural barriers by providing OPI services to our customers. We offer our customers a high-quality, cost-effective alternative to staffing in-house multilingual employees or using face-to-face interpretation. Through our OPI services, we improve our customers’ revenue potential, customer service and competitiveness by enhancing their ability to effectively serve the growing population of current and prospective LEP speakers.
Overview of Operations
Our operating revenues are derived primarily from per minute fees charged to our customers for our interpretation services. Generally, customers are charged based on the product of actual billed minutes of service and the customer’s contractual rate per billed minute of service. In addition, the Company generates revenue from membership and enrollment fees, as well as fees for other OPI-related services, such as document translation.
Expenses consist primarily of costs of services, selling, general and administrative expenses, depreciation and amortization and interest expense. Costs of services primarily include the cost of our interpreters, answer points and telecommunications costs.
Critical Accounting Policies and Estimates
Our significant accounting policies summarized in “Note 1—Organization and Summary of Significant Accounting Policies” in the Notes to Consolidated Financial Statements included in Item 8, have been prepared in accordance with Accounting Principles Generally Accepted in the United States of America (“GAAP”). In preparing the consolidated financial statements, GAAP requires management to select and apply accounting policies that involve estimates and judgment. The following accounting policies may require a higher degree of judgment or involve amounts that could have a material impact on the consolidated financial statements.
Allowance for Doubtful Accounts
We maintain an allowance for doubtful accounts for estimated losses resulting from the failure of customers to make payment. We determine the allowance based upon an evaluation of individual accounts, aging of the portfolio, issues raised by customers that may suggest non-payment, historical experience and/or the current economic environment. While our bad debt losses have historically been within our expectations and the allowance established, we might not continue to experience the same loss rates that we have in the past. If the financial condition of individual customers or the general worldwide economy were to vary materially from the estimates and assumptions made by us, the allowance may require adjustment in the future. We evaluate the adequacy of the allowance on a regular basis, modifying, as necessary, its assumptions, updating its record of historical experience and adjusting reserves as appropriate.
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Impairment of Long-Lived Assets
We assess the impairment of long-lived assets at least annually or when events or changes in circumstances indicate that the carrying value of the assets or the asset grouping may not be recoverable. Customer relationships, internally developed technology, tradenames and trademarks, and goodwill are our most significant long-lived assets and are tested annually. Impairment is measured by the difference between the carrying amount and the respective fair values, based on the best information available, including market prices or a discounted cash flow analysis. Estimates are made on the useful lives or economic values of assets and could change based on changes in the economy or industry trends.
Stock-Based Compensation
We account for stock-based compensation in accordance with Statement of Financial Accounting Standards (SFAS) No. 123(R), “Share Based Payment”. Under SFAS 123(R), the Company determines the fair value of its Language Line Holdings, LLC (“Holdings”) Class C restricted stock units pursuant to the probability-weighted expected return method. Under this method, the value of an enterprise’s common stock is estimated from an analysis of the future values for the Company assuming various possible future liquidity events. SFAS 123(R) requires that the Company recognize compensation expense for only the portion of restricted stock units that are expected to vest, rather than recording forfeitures when they occur, as previously permitted. If the actual number of forfeitures differs from those estimated by management, additional adjustments to compensation expense may be required in future periods.
Income Taxes
In preparing our consolidated financial statements, we are required to estimate our income taxes in each of the jurisdictions in which we operate. This process involves estimating actual current tax exposures together with assessing tax credits and temporary differences resulting from differing treatment of certain items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within the consolidated balance sheet. We then assess the likelihood of additional tax exposure, and to the extent we believe that additional tax exposure may be likely, we must record a liability for such matters. To the extent we increase this liability in a period, we include an expense within the tax provision in our consolidated statement of operations.
Significant management judgment is required in determining our provision for income taxes, income tax credits, deferred tax assets and liabilities. The recording of a liability based on additional tax exposure is based on estimates of taxable income by the jurisdictions in which we operate and the period over which amounts would be recoverable. In the event that actual results differ from these estimates or we adjust these estimates in future periods, we may need to adjust our income tax liability, which could impact our financial position and results of operations.
Claims and Legal Proceedings
In the normal course of business, we are party to various claims and legal proceedings. We record a reserve for these matters when an adverse outcome is probable and we can reasonably estimate our potential liability. Although the outcome of these matters is currently not determinable, we do not believe that the resolution of these matters in a manner adverse to our interest will have a material effect upon our financial condition, results of operations or cash flows for any interim or annual period.
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Historical Performance
Results of Operations
The following table sets forth the percentages of revenue that certain items of operating data constitute for the periods indicated:
| Predecessor | ||||||||||||
| Year Ended December 31, 2006 | Year Ended December 31, 2005 | June 12, 2004 to December 31, 2004 | January 1, 2004 to June 11, 2004 | |||||||||
Statement of Operations Data: | ||||||||||||
Revenues | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | ||||
Costs of services | 35.4 | % | 34.0 | % | 32.4 | % | 33.3 | % | ||||
Other expenses: | ||||||||||||
Selling, general and administrative | 17.7 | % | 17.0 | % | 15.5 | % | 16.1 | % | ||||
Interest | 33.2 | % | 34.6 | % | 32.0 | % | 9.3 | % | ||||
Merger related expenses | — | — | 0.1 | % | 15.2 | % | ||||||
Depreciation and amortization | 22.3 | % | 27.1 | % | 27.0 | % | 2.7 | % | ||||
Total other expenses | 73.2 | % | 78.7 | % | 74.6 | % | 43.3 | % | ||||
Other income: | ||||||||||||
Interest | 0.5 | % | 0.2 | % | 0.4 | % | 0.1 | % | ||||
Escrow settlement | 0.5 | % | — | — | — | |||||||
Total other income | 1.0 | % | 0.2 | % | 0.4 | % | 0.1 | % | ||||
Income (loss) before income taxes | (7.6 | %) | (12.5 | %) | (6.6 | %) | 23.5 | % | ||||
Income tax provision (benefit) | (1.8 | %) | (5.8 | %) | (2.0 | %) | 9.2 | % | ||||
Net income (loss) | (5.8 | %) | (6.7 | %) | (4.6 | %) | 14.3 | % | ||||
In the discussion of our financial statements for the year ended December 31, 2006 compared to the year ended December 31, 2005, and for the year ended December 31, 2005 compared to the year ended December 31, 2004 in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” we refer to financial statements for the year ended December 31, 2004 as “combined” for comparative purposes. Those combined financial results for the year ended December 31, 2004 represent the sum of the financial data for Language Line Holdings, Inc. (Predecessor) for the period January 1, 2004 through June 11, 2004 and the financial data for Language Line Holdings, Inc. for the period from its inception at June 12, 2004 through December 31, 2004. We further refer to the period from our inception at June 12, 2004 through December 31, 2004 as the June 12, 2004 through December 31, 2004 period, because we had no operations in the period from April 14, 2004, our date of incorporation, to June 11, 2004, the closing date of the Merger. These combined financial results are for informational purposes only and do not purport to represent what our financial position would have actually been in such periods had the Merger occurred prior to June 11, 2004. The statement of operations data of the Predecessor is not directly comparable to that for the Company as the financial statements were derived from separate entities with a different accounting basis.
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Year Ended December 31, 2006 Compared to Year Ended December 31, 2005.
Revenues for the year ended December 31, 2006 were $163.3 million as compared to $144.9 million for the year ended December 31, 2005, an increase of $18.4 million or 12.7%. The majority of this increase in revenue is driven by a 18.7% increase in OPI billed minutes, offset by an 5.0% decline in the average rate per billed minute driven by our pricing strategy. Our pricing strategy is designed to increase revenues by opportunistically reducing average rate per minute pricing in order to stimulate growth in billed minute volume.
For the year ended December 31, 2006, total costs of services was $57.8 million as compared to $49.3 million for the year ended December 31, 2005, an increase of $8.5 million or 17.2%. This increase was primarily due to increased interpretation minutes, partially offset by efficiencies gained from continued business process improvements.
Selling, general and administrative expenses for the year ended December 31, 2006 were $28.9 million as compared to $24.6 million for the year ended December 31, 2005, an increase of $4.3 million or 17.5%. This increase was primarily due to the results of an increase in sales initiatives, in addition to increased audit and tax related fees.
Interest expense for the year ended December 31, 2006 was $54.2 million as compared to $50.1 million for the year ended December 31, 2005, an increase of $4.1 million or 8.2%. This increase was the result of an increase in interest expense for our senior discount note along with higher LIBOR interest rates.
Interest income for the year ended December 31, 2006 was $0.8 million as compared to $0.3 million for the year ended December 31, 2005, an increase of $0.5 million or 166.7%. This increase was the result of higher interest rates and higher cash balances throughout the year.
Depreciation and amortization was $36.4 million for the year ended December 31, 2006 as compared to $39.2 million for the year ended December 31, 2005, a decrease of $2.8 million or 7.1%. This decrease was principally attributable to an intangible asset being fully amortized in 2006.
Escrow settlement of $795,000 for the year ended December 31, 2006 was a result of final settlement of the escrow account related to the Merger. Final settlement of the escrow account was reached with the previous owners on July 25, 2006. In final settlement of the escrow account, the Company received $795,000 for potential tax liabilities. As the Company had already recorded these additional tax liabilities subsequent to the Merger and concluded there is not a clear and direct link to the original purchase price, the settlement amount of $795,000 was recorded into other income in the third quarter of 2006.
Tax benefit on loss for the year ended December 31, 2006 was $2.9 million compared to $8.5 million of tax benefit on loss for the year ended December 31, 2005, a decrease of $5.6 million, primarily due to a decrease in loss before income taxes. The effective tax rate for the year ended December 31, 2006 was 23.3% as compared to 46.8% for the year ended December 31, 2005. The decrease in the effective rate of the tax benefit is primarily due to (1) the effects of a change in the estimated state tax rate on deferred taxes in 2005, (2) an increase in accruals for unresolved tax issues in 2006, and (3) an increase in the amount of expenses not deductible for tax purposes (principally nondeductible interest related to senior discount notes and expenses related to a deferred stock compensation plan) in conjunction with a decrease in loss before income taxes.
As a result of the factors described above, net loss was $9.5 million for the year ended December 31, 2006 as compared to net loss of $9.6 million for the year ended December 31, 2005, a decrease of $0.1 million or 1.0%.
Year Ended December 31, 2005 Compared to Year Ended December 31, 2004.
Revenues for the year ended December 31, 2005 were $144.9 million as compared to $145.0 million for the year ended December 31, 2004, a decrease of $0.1 million or 0.1%. The decrease relates to a decline in average rate per billed minutes. Our pricing strategy is designed to increase revenues by opportunistically reducing average rate per minute pricing in order to stimulate growth in billed minute volume.
For the year ended December 31, 2005, costs of services were $49.3 million as compared to $47.5 million for the year ended December 31, 2004, an increase of $1.8 million or 3.8%. This increase was primarily due to increased interpretation minutes, partially offset by efficiencies gained from continued business process improvements.
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Selling, general and administrative expenses for the year ended December 31, 2005 were $24.6 million as compared to $22.9 million for the year ended December 31, 2004, an increase of $1.7 million or 7.4%. This increase was primarily due to the results of an increase in sales initiatives, in addition to increased audit and tax related fees.
Interest expense for the year ended December 31, 2005 was $50.1 million as compared to $31.7 million for the year ended December 31, 2004, an increase of $18.4 million or 58.0%. This increase was the result of additional debt outstanding, incurred as part of the Merger, for only part of the prior year but all of the current year.
Interest income for the year ended December 31, 2005 was $0.3 million as compared to $0.3 million for the year ended December 31, 2004. There was no change in interest income given that there were no large fluctuations in interest rates and cash balances throughout the year.
There were no Merger related expenses for the year ended December 31, 2005 compared to $9.9 million for the year ended December 31, 2004. Of the $9.9 million of Merger related expenses incurred in the year ended December 31, 2004, $9.6 was related to the write-off of the Predecessor’s deferred financing fees.
Depreciation and amortization was $39.2 million for the year ended December 31, 2005 as compared to $23.4 million for the year ended December 31, 2004, an increase of $15.8 million or 67.5%. This increase was principally attributable to the amortization of intangibles, resulting from the Merger, for part of the prior year but all of the current year.
Tax benefit on loss for the year ended December 31, 2005 was $8.5 million as compared to tax expense on income of $4.4 million for the year ended December 31, 2004. This change from an expense to a benefit was driven by additional interest, depreciation and amortization.
As a result of the factors described above, net loss was $9.6 million for the year ended December 31, 2005 as compared to net income of $5.5 million for the year ended December 31, 2004, a decrease of $15.1 million or 274.6%.
Liquidity and Capital Resources
Operating Activities. Net cash provided by operating activities was $30.1 million for the year ended December 31, 2006 compared to $27.0 million for the year ended December 31, 2005, an increase of $3.1 million or 11.5%. This increase was mainly attributable to improved net loss in 2006 offset by an increase in cash interest payments of $7.3 million and an increase in cash tax payments of $1.5 million. Net cash provided by operating activities for the years ended December 31, 2005 and 2004 were $27.0 million and $46.3 million, respectively, a decrease of $19.3 million or 41.7%. This decrease was mainly attributable to an increase in costs of services in 2005, an increase in accounts receivable of approximately $2.7 million, an increase in cash interest payments of $9.3 million and an increase in cash tax payments of $4.1 million.
Investing Activities. Net cash used for investing activities was $2.9 million for the year ended December 31, 2006, compared to $1.6 million for the year ended December 31, 2005, an increase of $1.3 million or 81.3%. This increase was attributable to capital expenditures spending. Net cash used for investing activities for the years ended December 31, 2005 and 2004 were $1.6 million and 718.4 million, respectively, a decrease of 716.8 million or 99.8%. This decrease was mainly attributable to the Merger.
Financing Activities. Net cash used by financing activities for the year ended December 31, 2006 was $21.0 million, compared to net cash used of $23.6 million for the year ended December 31, 2005. The decrease of $2.6 million is the result of lower debt repayments, offset by payments related to loan fees and financing costs. Net cash used by financing activities for the year ended December 31, 2005 was $23.6 million, compared to net cash provided of 691.2 million for the year ended December 31, 2004. The decrease of 714.8 million is the result of issuance of common stock and debt borrowing related to the Merger, partially offset by payments related to loan fees and financing costs associated with the Merger.
Our principal sources of liquidity are cash flow from operations and borrowings under our senior secured credit facilities. We believe that these funds will provide us with sufficient liquidity and capital resources for us to meet our current and future financial obligations, including our scheduled principal and interest payments, as well as to provide funds for working capital, capital expenditures, and other needs. Our principal uses of cash are debt service requirements, capital expenditures, and working capital requirements.
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Debt Service. As of December 31, 2006, we had total indebtedness of $476.1 million and $40.0 million of borrowings available under our revolver credit facility, as defined in our loan agreement.
The senior secured credit facilities consist of a six-year $40.0 million revolving credit facility and a seven-year amortizing $285.0 million term loan facility. Borrowings under the senior credit facilities generally bear interest based on a margin over, at our option, the base rate or the reserve-adjusted LIBOR. The applicable margin for revolving credit loans will vary based upon our leverage ratio as defined in the senior credit facilities. The senior credit facilities are collateralized by first priority interests in, and mortgages on, substantially all of our tangible and intangible assets and first priority pledges of all the equity interest owned by us in our existing and future domestic subsidiaries.
Our senior subordinated notes mature in 2012 and are guaranteed by each of our existing domestic restricted subsidiaries.
Our senior discount notes mature in 2013 and rank senior to all subordinated indebtedness.
Capital Expenditures. We expect to spend approximately $3.0 million in 2007 and approximately $3.0 million in 2008 to fund our capital expenditures as well as normal investments in telecommunications and company equipment. We plan to fund these expenditures through net cash flows from operations.
We believe that the cash generated from operations will be sufficient to meet our debt service, capital expenditures and working capital requirements for the foreseeable future. Subject to restrictions in our senior secured credit facilities and the indentures governing the notes, we may incur more debt for working capital, capital expenditures, acquisitions and for other purposes. In addition, we may require additional financing if our plans materially change in an adverse manner or prove to be materially inaccurate. There can be no assurance that such financing, if permitted under the terms of our debt agreements, will be available on terms acceptable to us or at all.
Contractual Obligations
The following table sets forth our long-term contractual cash obligations as of December 31, 2006 (dollars in thousands):
| Years Ending December 31, | |||||||||||||||||||||
| Total | 2007 | 2008 | 2009 | 2010 | 2011 | Thereafter | |||||||||||||||
Senior secured credit facilities | $ | 236,432 | $ | 17,251 | $ | 12,630 | $ | 12,630 | $ | 12,630 | $ | 181,291 | $ | — | |||||||
Senior subordinated notes offered by Language Line, Inc. | 165,000 | — | — | — | — | — | 165,000 | ||||||||||||||
Senior discount notes | 108,993 | — | — | — | — | 108,993 | |||||||||||||||
Interest payments | 241,963 | 37,984 | 36,798 | 43,410 | 50,021 | 41,479 | 32,271 | ||||||||||||||
Operating leases | 8,709 | 4,050 | 2,660 | 1,023 | 831 | 145 | — | ||||||||||||||
Total cash contractual obligations | $ | 761,097 | $ | 59,285 | $ | 52,088 | $ | 57,063 | $ | 63,482 | $ | 222,915 | $ | 306,264 | |||||||
Interest payments with respect to the senior secured credit facilities assume a variable rate of 8.63%, which represents the most
recent rate applicable to these facilitities. Both the senior subordinated notes offered by Language line, Inc. and the senior discount
notes are 11 1/8% and 14 1/8% fixed rate notes, respectively. The senior discount note cash interest payments start in December 2009.
Recent Accounting Pronouncements
We adopted Statement of Financial Accounting Standards (SFAS) No. 123(R), “Share Based Payment” as of January 1, 2006. Under SFAS 123(R), the Company determines the fair value of its Holdings Class C restricted stock units from the probability-weighted expected return method. Under this method, the value of an enterprise’s common stock is estimated from an analysis of the future values for the Company assuming various possible future liquidity events. SFAS 123(R) requires that the Company recognize compensation expense for only the portion of Holdings Class C restricted stock units that are expected to vest, rather than recording forfeitures when they occur, as previously permitted. If the actual number of forfeitures differs from those estimated by management, additional adjustments to compensation expense may be required in future periods.
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In June 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48 prescribes guidance for the recognition and measurement of a tax position taken or expected to be taken in a tax return. Recognition of an asset or liability is required if it is more likely than not that a tax position will be sustained upon examination, including resolution of any related appeals or litigation processes. The provisions of FIN 48 are effective for us on January 1, 2007, with the cumulative effect of the change in accounting principle, if any, recorded as an adjustment to opening retained earnings. We anticipate the effect to our balance sheet as of January 1, 2007 to be immaterial.
In September 2006, the FASB issued SFAS No. 157 (“SFAS 157”) “Fair Value Measurements,” which defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS 157 applies to other accounting pronouncements that require or permit fair value measurements. It is effective for us beginning in fiscal year 2008. We are currently evaluating the impact of adopting SFAS 157.
On February 15, 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (FAS 159). This Statement is a fair value option for financial assets and financial liabilities and includes an amendment of FASB Statement No. 115 which covers accounting for certain investments in debt and equity securities. It is effective for us beginning in fiscal year 2008. We are currently evaluating the impact of adopting SFAS 159.
In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin (“SAB”) No. 108,“Considering the Effects of Prior Year Misstatements when Quantifying Current Year Misstatements”. SAB No. 108 requires analysis of misstatements using both an income statement (rollover) approach and a balance sheet (iron curtain) approach in assessing materiality, either of which was previously acceptable, and provides for a one-time cumulative effect transition adjustment. We adopted SAB No. 108 on its effective date, December 31, 2006, and it had no effect on our financial statements.
Escrow Settlement
On June 11, 2004 as part of the Merger, $30.0 million of the Merger consideration was deposited into an escrow account on behalf of the stockholders and optionholders of the Predecessor to secure their potential indemnity obligations to LLI. Since the Merger, periodic payments from the escrow account have been paid to the stockholders and optionholders of the Predecessor according to a pre-determined payment schedule. Final settlement of the escrow account was reached with the previous owners on July 25, 2006. In final settlement of the escrow account, the Company received $795,000 for potential tax liabilities. As the Company had already recorded these additional tax liabilities subsequent to the Merger and concluded there is not a clear and direct link to the original purchase price, the settlement amount of $795,000 was recorded into other income in the third quarter of 2006.
Debt Refinancing
On November 14, 2006, the Company entered into an Amended and Restated Credit Agreement (the “Agreement”) which amends and restates the Original Credit Agreement dated as of June 11, 2004 and amended as of November 3, 2005, among LLI, the Company, the subsidiary guarantors party thereto.
The Agreement effects a refinancing and replacement of the Tranche B Term Loans currently outstanding under the Original Credit Agreement with a new class of Term Loans designated as “Tranche B-1 Term Loans”. The aggregate principal amount of the modified loan is equal to the aggregate principal amount of original loan under the Original Credit Agreement. The modified loan has terms, rights and obligations materially identical to the original loan except that the Applicable Margin for borrowings under the modified loan is 3.25% in the case of Eurodollar loans and 2.25% in the case of Alternate Base Rate Loans. In addition, the Agreement amended related definitions and contained immaterial modifications to various other provisions of the Original Credit Agreement
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Off-Balance Sheet Arrangements
We do not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.
ITEM 7A: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to certain market risks as part of our ongoing business operations. Primary exposure will include changes in interest rates, as borrowings under our senior secured credit facilities bear interest at floating rates based on LIBOR or the base rate, in each case plus an applicable borrowing margin. We will manage our interest rate risk by balancing our amount of fixed-rate and floating-rate debt. For fixed-rate debt, interest rate changes do not affect our earnings or cash flows. Conversely, for floating-rate debt, interest rate changes generally impact our earnings and cash flows, assuming other factors are held constant.
As of December 31, 2006, we had $274.0 million principal amount of fixed-rate debt and $276.4 million of available floating-rate debt (of which we borrowed $236.4 million). Based on the pro forma amounts outstanding under the revolver credit facility and the term loan, a hypothetical increase of one percentage point would cause an increase to interest expense of approximately $2.5 million on an annual basis on the floating rate debt.
Changes in economic conditions could result in higher interest rates, thereby increasing our interest expense and other operating expenses and reducing our funds available for capital investment, operations or other purposes. In addition, a substantial portion of our cash flow must be used to service debt, which may affect our ability to make future acquisitions or capital expenditures. We may from time to time use interest rate protection agreements to minimize our exposure to interest rate fluctuation. However, there can be no assurance that hedges will achieve the desired effect. We may experience economic loss and a negative impact on earnings or net assets as a result of interest rate fluctuations.
ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by Item 8 is incorporated by reference herein from Part IV, Item 15(a)(1) and (2).
ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
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ITEM 9A: CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
The Company maintains disclosure controls and procedures (as defined in Rule 13a–15(e) and 15d–15(e) under the Securities Exchange Act of 1934) that are designed to ensure that information required to be disclosed in the Company’s Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the Commission’s rules and forms, and that such information is accumulated and communicated to the Company’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
The Company’s management has evaluated the effectiveness of the Company’s disclosure controls and procedures as of the end of the period covered by this report. Based on such evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, the Company’s disclosure controls and procedures were effective.
Changes in Internal Control Over Financial Reporting
There have not been any changes in the Company’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the most recent fiscal year that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Not applicable.
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ITEM 10: DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Our Board of Directors is divided into two classes, employees and non-employees, with the non-employee directors represented by ABRY Partners, LLC (“ABRY”). Directors in each class have no designated term limits. Decisions regarding directors terms are made at the discretion of the ABRY directors. There are no family relationships among the directors and executive officers. The following table sets forth certain information regarding our directors and executive officers as of March 31, 2007.
Name | Age | Position | ||
Dennis G. Dracup | 53 | Chief Executive Officer and Director | ||
Louis F. Provenzano | 47 | President, Chief Operating Officer and Director | ||
Jeffrey C. Grace | 44 | Chief Financial Officer and Director | ||
James L. Moore Jr. | 61 | Chief Information Officer | ||
Yung-Chung Heh | 44 | Vice President of Global Operations | ||
Karen Gilhooly | 48 | Senior Vice President of Sales | ||
Jeffrey M. Johnson | 41 | Vice President of Business Development | ||
C.J. Brucato | 33 | Director | ||
Peggy Koenig | 50 | Director | ||
Azra Nanji | 26 | Director |
Dennis G. Dracupjoined us in 2001 as President and Chief Executive Officer and became a Director upon closing of the Merger. Prior to joining us and since 1996, Mr. Dracup was the Chief Executive Officer of Gemkey.com and the President of Pitney Bowes Software Solutions. Mr. Dracup earned his Executive Management Certificate from Northwestern University, M.S. in Information Systems from Roosevelt University, M.B.A. from State University of New York at Buffalo and B.A. in English from Canisius College.
Louis F. Provenzano has served as the Company’s President, Chief Operating Officer and Director since October 2006 and as Executive Vice President of Sales and Marketing since October 1, 2005. Mr. Provenzano joined us in November 2004 as Senior Vice President of Sales. Prior to joining us and since December 2002, Mr. Provenzano was Vice President of Worldwide Sales and Account Management for Metavante, a subsidiary of M&I Bank. Prior to that and since 1989, Mr. Provenzano held positions of Vice President of Worldwide Sales for Alysis Technologies (acquired by Pitney Bowes) and Senior Vice President of Loan Pricing Corporation (acquired by Reuters). Mr. Provenzano earned a B.A. degree from Boston College.
Jeffrey C. Grace has served as the Company’s Chief Financial Officer and Director since December 2006. Mr. Grace joined us in October 2004 as Controller. Prior to joining us and since December 1997, Mr. Grace was Vice President of Finance for Excelligence Learning Corporation. Prior to that and since 1993 Mr. Grace was an Executive Associate for EAB Associates. Mr. Grace began his career with Deloitte & Touche LLP. Mr. Grace is a Certified Public Accountant and earned a B.A. in Finance from California State University, Los Angeles.
James L. Moore Jr. joined us in 2000 as Chief Information Officer. Prior to joining us and since 1998, Mr. Moore was the Chief Information Officer of Borland Software Corporation and Director of Information Systems of Softbank Content Services Inc. Mr. Moore earned his M.S. and B.A. in Engineering from California State University Northridge.
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Yung-Chung Hehjoined the Company in 1989. Prior to her current position as Vice President, Global Operations, she was Vice President of International Sales. Prior to that, she was Director of Marketing and Sales and Director of Operations. Ms. Heh as an A.A. degree in Accounting, and a B.A. in English. She earned her M.A. in Translation and Interpretation (Chinese/English) from the Monterey Institute of International Studies.
Karen Gilhoolyjoined the Company in September 2006. Prior to joining the Company, Ms. Gilhooly was with Citigroup where she served as Managing Director of the Global Transactions group in the Corporate Investment Bank. In this capacity, Ms. Gilhooly led the North America sales effort for international payments and product franchising. Though the majority of Ms. Gilhooly’s career was spent with Citigroup in a variety of business management roles, she also held senior leadership positions in companies engaged in the emerging online bill payment technologies including Metavante, Intelidata and Princeton eCom. Ms Gilhooly attended the University of Illinois where she majored in History and English. She is a certified expert in several sales and business management disciplines.
Jeffrey M. Johnson has served as Vice President, Business Development since July, 2006. Mr. Johnson joined Language Line Services in 2002 in a Market Management position and in 2004 held the Director of Marketing position. Prior to Language Line Services, Mr. Johnson held senior Operations and Marketing positions at Pitney Bowes. Mr. Johnson holds an MBA with distinction from Northwestern University’s J.L. Kellogg Graduate School of Management, and a Bachelor of Science degree with honors from California Polytechnic State University
C.J. Brucato became a Director in June 2004. Mr. Brucato is a Principal of ABRY Partners, LLC, which he joined in 1996. Prior to joining ABRY, Mr. Brucato was a member of the Media, Telecommunications and Entertainment Investment Banking Group at Prudential Securities, Inc. He is presently a director (or the equivalent) of CapRock Holdings, Inc., CommerceConnect Media Holdings, Inc., Consolidated Theatres, LLC, Fanfare Media Works Holdings, Inc. and Hispanic Yellow Pages Network, LLC. Mr. Brucato earned his B.S.E. from Princeton University.
Peggy Koenig became a Director in June 2004. Ms. Koenig is a Managing Partner of ABRY Partners, LLC, which she joined in 1993. From 1988 to 1992, Ms. Koenig was a Vice President, Partner and member of the board of directors of Sillerman Communication Management Corporation, a merchant bank, which made investments principally in the radio industry and was responsible for the formation of the public radio company, SFX Broadcasting, Inc. From 1986 to 1988, Ms. Koenig was the Director of Finance for Magera Management, an independent motion picture financing company for Columbia and Tri-Star Pictures. She is presently a director (or the equivalent) of Commerce Connect Media Holdings, Inc., Fanfare Media Works Holdings, Inc., Hispanic Yellow Pages Network, LLC, Psychological Services, Inc. and ftw Publications. Ms. Koenig received her undergraduate degree from Cornell University and an M.B.A. from the Wharton School of the University of Pennsylvania.
Azra Nanji became a Director in June 2004. Ms. Nanji is a Vice President at ABRY Partners, LLC, which she joined in 2003. From 2001 to 2003, Ms. Nanji was an analyst in the Communications, Media, and Entertainment group at Goldman Sachs. She is presently a director of Country Road Communications and PSI. Ms. Nanji received her undergraduate degree from Duke University.
In connection with the purchase of a significant portion of the senior discount notes offered by us or equity securities of our ultimate parent company, certain third-parties obtained a right to designate observers to our board of directors.
Audit Committee
Our Board has a separately-designated standing Audit Committee. The members of the Audit Committee are C.J. Brucato, Peggy Koenig and Azra Nanji. Since our equity is not currently listed on or with a national securities exchange or national securities association, we are not required to have an audit committee and therefore have not designated any of our Audit Committee members as an audit committee financial expert.
Code of Business Conduct and Ethics
Our Company has adopted a Code of Business Conduct and Ethics (the “Code”) applicable to our Company’s directors, officers (including the Chief Executive Officer, Chief Financial Officer, Controller and persons performing similar functions), employees, agents and consultants. Our Code satisfies the requirements of a “code of ethics” within the meaning of Section 406 of the Sarbanes-Oxley Act of 2002 and the rules issued by the Securities and Exchange Commission thereunder. Amendments to, or waivers from, a provision of our Code that apply to our Company’s directors or executive officers, including the Chief Executive Officer, Chief Financial Officer, Controller and persons performing similar functions, may be made only by the Company’s board of directors. Our Company has not amended the Code and has filed the Code as an exhibit to this Annual Report on Form 10-K.
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ITEM 11: EXECUTIVE COMPENSATION
COMPENSATION COMMITTEE REPORT
Because affiliates of ABRY own more than 50% of the voting common stock of Language Line Holdings, LLC (“Holdings’), we would be a “controlled company” within the meaning of Rule 4350(c)(5) of the Nasdaq Marketplace rules, which would qualify us for exemptions from certain corporate governance rules of The Nasdaq Stock Market LLC, including the requirement that compensation be determined by a majority of independent directors, or a compensation committee comprised solely of independent directors. As such, we do not have a standing compensation committee. However, decisions regarding compensation of the individuals named in the Summary Compensation Table (the “named executive officers”) and directors are made by certain of our non-employee directors, Peggy Koenig, C.J. Brucato and Azra Nanji, with Peggy Koenig acting as the chairperson. These individuals are referred to herein as the Compensation Committee.
The Compensation Committee has reviewed and discussed the Compensation Discussion and Analysis with management and, based on its review and discussions, the Compensation Committee recommended to the board of directors that the Compensation Discussion and Analysis be included in the annual report on Form 10K.
This report has been provided by the Compensation Committee of the Board of Directors of the Company.
Peggy Koenig, Director, Chairperson of the Compensation Committee
C.J. Brucato, Director
Azra Nanji, Director
COMPENSATION DISCUSSION AND ANALYSIS
Our Compensation Committee is responsible for reviewing and approving the compensation of our named executive officers as well as reviewing and approving our incentive plans all presented by our Chief Executive Officer. Review and approval of compensation and incentives by the Compensation Committee is done annually as part of the Company’s budget review as well as on an as-needed basis, with the Board of Directors either approving or rejecting the Compensation Committee recommendations. The Compensation Committee is comprised solely of non-employee directors, consisting of Peggy Koenig, C.J. Brucato and Azra Nanji, with Peggy Koenig acting as the chairperson.
Compensation Objectives
We believe that our compensation program must support our strategy, be competitive, and provide both significant rewards for outstanding performance and clear financial consequences for underperformance. We also believe that a significant portion of the named executive officers’ compensation should be “at risk” in the form of annual and long-term incentive awards that are paid, if at all, based on individual and company accomplishment. The compensation awarded to our named executive officers for fiscal 2006, as well as prior years, was intended:
| • | To encourage and reward strong performance; and |
| • | To motivate our named executive officers by providing them with a meaningful equity stake in the company. |
Accounting and cost implications of compensation programs are considered in program design; however, the main driver of design is alignment with out business needs.
Role of the Compensation Committee and Executive Officers
The Compensation Committee of the Board of Directors approves and then recommends that the Board of Directors approve their recommendations for all compensation and awards to named executive officers, which include the chief executive officer, chief financial officer and the president/chief operating officer. For the remaining executive officers, the chief executive officer makes recommendations to the Compensation Committee that generally, with minor adjustments, are approved. With respect to equity compensation awarded to others, the chief executive officer recommends to the Compensation Committee the amounts of restricted stock to be granted. The Compensation Committee reviews and recommends that the Board of Directors approve their final recommendations.
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Elements of our Compensation Program
Base Salary
Base salary is intended to provide fixed compensation to the named executive officers for their performance of core duties that contributed to our success as measured by the element of corporate performance mentioned above. The Compensation Committee reviews and approves base salary recommendations as presented by the chief executive officer. Base salary recommendations are intended to approximate the market value of a position, based on analysis of similar positions with essentially the same job responsibilities. Market data is provided to the Company by nationally recognized compensation consulting firms and executive search firms.
Annual Incentives
Annual incentives in the form of the Company’s “Bonus Plan” are intended to tie a significant portion of each of the named executive officer’s compensation to our annual performance. Additionally, the annual incentive allows us to recognize an individual’s performance in relation to special or strategic projects. The annual incentives paid in 2007 for 2006 performance were based primarily upon the performance of the Company. The Bonus Plan is tied to both revenue and EBITDA growth over the prior year. For example, revenue and EBITDA growth over prior year were approximately 13% and 8%, respectively, resulting in bonuses earned by our named executive officers ranging from 45% to 58% of their respective base salaries.
Outside of the Company’s “Bonus Plan”, there is no other non-equity incentive compensation plan.
Long-Term Incentives
We believe that our long term success depends upon aligning executives’ and ownerships’ interests. To support this objective we provide our executives with means to become significant shareholders through the issuance of Holdings Class C restricted stock units, to support long-term retention of executives and reinforce our longer-term goals.
The Holdings Class C restricted stock units will vest according to a specified schedule and will be expensed to compensation over the vesting period of five years. Vesting will accelerate upon a change of control of Holdings, (as such term is defined in their incentive unit agreement) and upon certain types of sales. Vesting will cease if the individual ceases to be employed by Holdings or any of its subsidiaries. If the individual ceases to be employed by Holdings, or any of its subsidiaries, Holdings, will have the option to purchase all or any portion of the vested and/or the unvested restricted Class C restricted stock units. The aggregate purchase price for all unvested units will be $1.00, and the purchase price for each vested unit will be the fair market value for such unit as of the date of individual’s termination. If, however, the Company terminates the individual’s employment for cause, the aggregate purchase price of all vested units will be $1.00. Holdings’ right to repurchase the individual’s units will terminate upon a change of control, provided that the individual is employed by Holdings, or any of its subsidiaries at the time of the change of control.
Historically, the date upon which equity awards have been granted has not been fixed since there is no restricted stock unit plan. If we do grant restricted stock unit awards in the future, they shall be presented to the Compensation Committee for review and approval before being granted.
There are no outstanding or exercisable options with respect to any stock incentive plans at December 31, 2006. The Company currently has no stock option incentive plans.
Compensation Determination
In determining compensation amounts awarded, the Compensation Committee focused primarily on both revenue and EBITDA growth during 2006 in addition to adjusting base salaries as deemed appropriate.
Supplemental Benefits, Deferred Compensation and Perquisites
We do not provide supplemental benefits and perquisites for executives. None of our named executive officers have deferred any portion of their compensation, except for 401k contributions and medical benefits paid.
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Our Benefit Plans
We maintain a 401(k) retirement plan, under which employees may elect to make tax deferred contributions to a maximum established annually by the IRS. For employees meeting a six-month service requirement, we match 66.67% of the employees’ contributions up to a maximum of 6.0% of the employees’ compensation. Our contributions vest after three years of service. Predecessor contributions were approximately $193,000 for the period from January 1, 2004 to June 11, 2004, respectively. Company contributions were approximately $238,000 and $433,000 for the period from June 12, 2004 to December 31, 2004 and for the year ended December 31, 2005, respectively. Company contributions were approximately $445,000 for the year ended December 31, 2006.
We also provide a variety of standard welfare benefits to our employees, such as medical, dental, vision, short-term and long-term disability, and life insurance and accidental death and dismemberment benefits. A flexible spending plan, an employee assistance program and incentive compensation is also provided to employees.
Instead of the benefit programs described above, our employees in the United Kingdom receive the employee benefits set forth in their offer of employment letters, and the employees we lease through leasing companies receive benefits only through the leasing company, not through any of our employee benefit programs.
Employment Agreements
Generally, we do not favor employment agreements unless they are required to attract or retain an executive to the Company. We have entered into an employment agreement with our Chief Executive Officer, Dennis G. Dracup, as described in the narrative accompanying the Summary Compensation Table. The employment agreement with Mr. Dracup was essential to attract and/or retain his services.
In addition, the balance of the named officers have executed offer letters setting forth their beginning base salary and their eligibility to participate in the Company’s Bonus Plan. There is no length of employment provisions in any of their respective offer letters.
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Summary Compensation Table
The following table sets forth information concerning the compensation for fiscal 2006 for our Chief Executive Officer, Chief Financial Officer and each of our other three most highly compensated executive officers whose aggregate salary and bonus (including amounts of salary and bonus foregone to receive non cash compensation) exceeded $100,000.
Name and Principal Position | Year | Salary ($) | Bonus ($) | Stock Awards (6) ($) | Change in Pension Value and Nonqualified Deferred Compensation Earnings (8) ($) | All Other Compensation (7) ($) | Total ($) | |||||||||||||
Dennis G. Dracup | 2006 | $ | 377,708 | $ | 192,938 | $ | 180,000 | $ | — | $ | 20,132 | $ | 770,778 | |||||||
Jeffrey C. Grace (2) | 2006 | $ | 171,372 | $ | 62,500 | $ | 54,500 | $ | — | $ | 11,121 | $ | 299,493 | |||||||
Louis F. Provenzano (1) | 2006 | $ | 216,667 | $ | 131,813 | $ | 98,000 | $ | — | $ | 12,910 | $ | 459,390 | |||||||
James L. Moore Jr. | 2006 | $ | 194,100 | $ | 113,245 | $ | 75,000 | $ | — | $ | 19,337 | $ | 401,682 | |||||||
Yung-Chung Heh (3) | 2006 | $ | 134,192 | $ | 85,750 | $ | 47,000 | $ | — | $ | 15,811 | $ | 282,753 | |||||||
Matthew T. Gibbs II (4) | 2006 | $ | 269,792 | $ | 137,813 | $ | 45,000 | $ | — | $ | 17,926 | $ | 470,531 | |||||||
Jeanne Anderson (5) | 2006 | $ | 96,787 | $ | 25,000 | $ | — | $ | — | $ | 3,725 | $ | 125,512 | |||||||
| (1) | Mr. Provenzano was appointed President and Chief Operating Officer in October 2006. Amounts earned during the year ended December 31, 2006 include $154,167 earned as Executive Vice President of Sales and Marketing, and $62,500 earned as President and Chief Operating Officer, where his annualized salary was $250,000. |
| (2) | Mr. Grace was appointed Chief Financial Officer in December 2006. Amounts earned during the year ended December 31, 2006 include $159,961 earned as Controller, where his annualized salary was $172,300, and $11,411 earned as Chief Financial Officer were his annualized salary was $212,300. |
| (3) | Ms. Heh was appointed Vice President of Global Operations in July, 2006. Amounts earned during the year ended December 31, 2006 include $59,192 earned as Vice President of International Sales, where her annualized salary was $120,000, and $75,000 earned as Senior Vice President of Global Operations where her annualized salary was $150,000. |
| (4) | Mr. Gibbs resigned as Chief Financial Officer of the Company effective December 12, 2006. Mr. Gibbs’ compensation is included in the Summary Compensation Table in accordance with Item 402(a)(3)(iii) of Regulation S-K. |
| (5) | Ms. Anderson resigned as Vice President of Operations of the Company effective July 11, 2006. Ms. Anderson’s compensation is included in the Summary Compensation Table in accordance with Item 402(a)(3)(iii) of Regulation S-K. |
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| (6) | The securities underlying all of the stock grants in 2006 are Holdings Class C restricted stock units and valued in accordance with Statement of Financial Accounting Standards (SFAS) No. 123(R), “Share Based Payments”. Under SFAS 123(R), the Company determines the fair value of Holdings Class C restricted stock units from the probability-weighted expected return method. Under this method, the value of an enterprise’s common stock is estimated from an analysis of the future values for the Company assuming various possible future liquidity events. |
The Holdings Class C restricted stock units will vest according to a specified schedule and will be expensed to compensation over the vesting period of five years. Vesting will accelerate upon a change of control of Holdings and upon certain types of sales. Vesting will cease if the individual ceases to be employed by Holdings or any of its subsidiaries. If the individual ceases to be employed by Holdings or any of its subsidiaries, Holdings will have the option to purchase all or any portion of the vested and/or the unvested restricted stock units. The aggregate purchase price for all unvested units will be $1.00, and the purchase price for each vested unit will be the fair market value for such unit as of the date of individual’s termination. If, however, the Company terminates the individual’s employment for cause, the aggregate purchase price of all vested units will be $1.00. Language Line Holdings, LLC’s right to repurchase the individual’s units will terminate upon a “change of control” (as such term is defined in their incentive unit agreement), provided that the individual is employed by Holdings or any of its subsidiaries at the time of the “change of control.”
The following reflects activity with respect to the granting of Holdings Class C restricted stock units for the year 2006:
Grant date of March 1, 2006 at $0.09/unit – Mr. D. Dracup – 2,000,000 units; Mr. M. Gibbs – 500,000 units; Mr. L. Provenzano – 200,000 units; Mr. J. Grace – 50,000 units; Ms. Y. Heh – 300,000 units; and Mr. J. Moore – 75,000 units.
Grant date of December 1, 2006 at $0.10/unit – Mr. L. Provenzano – 800,000 units; Mr. J. Grace – 500,000 units; and Ms. Y. Heh – 200,000 units.
| (7) | Represents matching contributions to the employee’s respective Company 401(k) account, medical benefits paid by the Company and life insurance premiums paid by the company, respectively, for the following individuals: Mr. D. Dracup - $8,407, $10,661 & $1,065; Mr. L. Provenzano - $8,667, $3,554 & $690; Mr. J. Grace - $6,855, $3,677 & $588; Mr. J. Moore - $7,764, $11,029 & $544; Ms. Y Heh - $4,368, $11,029 & $414; Mr. M. Gibbs - $6,135, $11,029 & $762; and for Ms. J. Anderson - $3,479, $0 & $246. |
| (8) | The Company does not have a pension program and there were no nonqualified deferred compensation earnings. |
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Employment Agreements
Concurrently with the Merger we entered into new employment agreements with Messrs. Dracup and Gibbs. The remaining Named Executive Officers are employed on an “at will” basis. The employment agreements for Messrs. Dracup and Gibbs provide for an initial term of five years with automatic one-year renewals unless otherwise terminated earlier or either party gives notice not to renew. Under the employment agreements, Mr. Dracup is paid a base salary of $350,000 per year and Mr. Gibbs is paid a base salary of $250,000 per year. The base salary will increase by 5% on each anniversary of the employment agreement. In the event the executive’s employment is terminated due to (i) the executive’s resignation “without good reason,” (ii) death, “disability” or other incapacity or (iii) by the Company with “cause” (as each such term is defined in each employment agreement), the executive is entitled to certain benefits but no severance payments. If the executive’s employment is terminated by the Company “without cause” or the executive resigns for “good reason” (as each such term is defined in each employment agreement), the executive is entitled to severance payments and certain benefits for a period of twelve months from the date of termination. Each executive will be required to sign a release as a condition to receiving any severance payments. Each employment agreement also contains noncompete provisions which restrict each of the executives from being involved in, during the longer of two years from the date of the closing of the Merger on June 11, 2004, and one year from the date of termination of employment, any business which is in competition with us.
Termination, Change of Control and Change of Responsibility Payments
Mr. Gibbs resigned as Chief Financial Officer of the Company effective December 12, 2006. Mr. Gibbs is entitled to severance payments representing the amount of salary that would be paid had he been employed for an additional two months and shall be paid in equal monthly installments at his current rate of salary, with the last payment being made on February 28, 2007.
Mr. Gibbs is entitled to receive the amount of bonus for fiscal year 2006 (based on the Investment Plan Target and Investment Plan currently in effect). Such bonus will be paid to Mr. Gibbs at the time that the Company pays a bonus to the Chief Executive Officer in 2007.
Mr. Gibbs is entitled to receive the health benefits at the same level as currently provided as of December 12, 2006 through December 31, 2007, with 100% of the premiums for such benefits to be paid by the Company.
The Company has extended coverage for Mr. Gibb’s under the Company’s Directors and Officers insurance policy through December 31, 2007.
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If a termination event had occurred as of December 31, 2006, we estimate that the value of the benefits to Mr. Dracup would have been as follows:
Reason for termination | Lump sum severance payment (1) | SERP (3) | Benefits (4) | (7) Accelerated vesting of stock awards | ||||||||||
Death | $ | — | $ | — | $ | 13,584 | $ | 349,092 | (5) | |||||
Disability | $ | — | $ | — | $ | 13,584 | $ | 349,092 | (5) | |||||
Termination by us without cause | $ | 588,147 | $ | — | $ | 13,584 | $ | 349,092 | (5) | |||||
Termination by us with cause | $ | — | $ | — | $ | 13,584 | $ | 1 | ||||||
Termination by Mr. Dracup for good reason | $ | 588,147 | $ | — | $ | 13,584 | $ | 349,092 | (5) | |||||
Change of control | $ | 588,147 | (2) | $ | — | $ | 13,584 | $ | 1,363,636 | (6) | ||||
Termination by Mr. Dracup without cause | $ | — | $ | — | $ | 13,584 | $ | 349,092 | (5) | |||||
| (1) | Amounts reflect the equivalent of twelve month’s salary or $385,875, plus the equivalent of the 2006 earned Bonus of $192,938, plus the equivalent of twelve month’s Group Life Insurance of $927.60, plus the equivalent of twelve month’s 401(K) match of $8,406.53. |
| (2) | This amount will be reduced by the value paid in cash or marketable securities with respect to Language Line Holdings, LLC restricted stock unit gains. |
| (3) | This is not applicable since there is no Supplemental Executive Retirement Plan (“SERP) with respect to Mr. Dracup’s employment contract. |
| (4) | Represents rates currently in effect for COBRA insurance benefits for twelve months totalling $13,584. |
| (5) | Represents 3,490,909 vested units at $0.10 per unit plus $1.00 in aggregate for unvested units. |
| (6) | Represents 13,636,364 units at $0.10 per unit. |
| (7) | Stock awards represent Holdings Class C restricted stock units. |
Please also see the description of severance provisions in “Employment Agreements” accompanying the Summary Compensation Table.
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Restricted Stock Unit Grants
The following table describes the Holdings Class C restricted stock units granted to our named executive officers during the year ended December 31, 2006. There are no outstanding or exercisable options with respect to any stock incentive plans at December 31, 2006. The Company currently has no stock option incentive plans.
2006 GRANTS OF AWARDS TABLE
Name | Grant Date | Approval Date | All Other Stock Awards: Number of Stock Units (1) (#) | Base Price of Awards ($/unit) | |||||
Dennis G. Dracup | 3/1/06 | 11/3/05 | 2,000,000 | $ | — | ||||
Jeffrey C. Grace | 3/1/06 | 11/3/05 | 50,000 | $ | — | ||||
| 12/1/06 | 11/2/06 | 500,000 | $ | — | |||||
Louis F. Provenzano | 3/1/06 | 11/3/05 | 200,000 | $ | — | ||||
| 12/1/06 | 11/2/06 | 800,000 | $ | — | |||||
James L. Moore Jr. | 3/1/06 | 11/3/05 | 75,000 | $ | — | ||||
Yung-Chung Heh | 3/1/06 | 11/3/05 | 300,000 | $ | — | ||||
| 12/1/06 | 11/2/06 | 200,000 | $ | — | |||||
Matthew T. Gibbs II (2) | 3/1/06 | 11/3/05 | 500,000 | $ | — | ||||
| (1) | Represent grants of Holdings Class C restricted stock units, which vest as follows based on the anniversary of the grant: year 1 - 10%; year 2 - 20%; year 3 - 20%; year 4 - 25%; year 5 - 25%. |
| (2) | The 500,000 units of Holdings Class C restricted stock units granted to Mr. Gibbs were forfeited when he resigned on December 11, 2006. |
Incentive Unit Agreements
Messrs. Dracup and Gibbs are each party to Holdings Class C restricted stock units, pursuant to which our ultimate parent, Holdings, issued Class C restricted stock units to the executive. The executive’s units will vest according to a specified schedule. Vesting will accelerate upon a change of control of Holdings and upon certain types of sales. Vesting will cease if the executive ceases to be employed by Holdings or any of its subsidiaries. If the executive ceases to be employed by Holdings or any of its subsidiaries, Holdings will have the option to purchase all or any portion of the vested and/or the unvested Class C Units. The aggregate purchase price for all unvested units is $1.00, and the purchase price for each vested unit will be the fair market value for such unit as of the date of executive’s termination. If, however, we terminate the executive’s employment for cause, the aggregate purchase price for all vested units will be $1.00. Holdings right to repurchase the executive’s units will terminate upon a “change of control” (as such term is defined in their incentive share agreement), provided that the executive is employed by Holdings or any of its subsidiaries at the time of the “change of control”.
Of Mr. Gibb’s 4,500,000 Holdings Class C restricted stock units, upon resignation on December 12, 2006, 300,000 vested units were repurchased at fair market value at a price of $0.09 per unit; 3,300,000 unvested units were purchased in aggregate for $1.00 and the Company chose to retain 900,000 units for Mr. Gibbs to keep on his behalf regardless of their vesting period.
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2006 OUTSTANDING EQUITY AWARDS AT FISCAL YEAR-END TABLE
Name | Number of Restricted Stock Units That Have Not Vested (#) | Market Value of Restricted Stock Units That Have Not Vested ($) | |||||
Dennis G. Dracup | 10,145,455 | (1) | $ | 1,014,545 | (7) | ||
Jeffrey C. Grace | 620,000 | (2) | $ | 62,000 | (7) | ||
Louis F. Provenzano | 1,350,000 | (3) | $ | 135,000 | (7) | ||
James L. Moore Jr. | 621,804 | (4) | $ | 62,180 | (7) | ||
Yung-Chung Heh | 640,000 | (5) | $ | 64,000 | (7) | ||
Matthew T. Gibbs II | 630,000 | (6) | $ | 63,000 | (7) | ||
| (1) | Represent Holdings Class C restricted stock units, which vest as follows: 3/1/07 - 200,000; 7/1/07 - 2,327,273; 3/1/08 - 400,000; 7/1/08 - 2,909,091; 3/1/09 - 400,000; 7/1/09 - 2,909,091; 3/1/10 - 500,000 and 3/1/11 - 500,000. |
| (2) | Represent Holdings Class C restricted stock units, which vest as follows: 3/1/07 - 5,000; 7/1/07 - 20,000; 12/1/07 - 50,000; 3/1/08 - 10,000; 7/1/08 - 25,000; 12/1/08 - 100,000; 3/1/09 - 10,000; 7/1/09 - 25,000; 12/1/09 - 100,000; 3/1/10 - 12,500; 12/1/10 - 125,000; 3/1/11 - 12,500 and 12/1/11 - 125,000. |
| (3) | Represent Holdings Class C restricted stock units, which vest as follows: 3/1/07 - 20,000; 7/1/07 - 100,000; 12/1/07 - 80,000; 3/1/08 - 40,000; 7/1/08 - 125,000; 12/1/08 - 160,000; 3/1/09 - 40,000; 7/1/09 - 125,000; 12/1/09 - 160,000; 3/1/10 - 50,000; 12/1/10 - 200,000; 3/1/11 - 50,000 and 12/1/11 - 200,000. |
| (4) | Represent Holdings Class C restricted stock units, which vest as follows: 3/1/07 - 7,500; 7/1/07 - 156,230; 3/1/08 - 15,000; 7/1/08 - 195,287; 3/1/09 - 15,000; 7/1/09 - 195,287; 3/1/10 - 18,750 and 3/1/11 - 18,750. |
| (5) | Represent Holdings Class C restricted stock units, which vest as follows: 3/1/07 - 30,000; 7/1/07 - 40,000; 12/1/07 - 20,000; 3/1/08 - 60,000; 7/1/08 - 50,000; 12/1/08 - 40,000; 3/1/09 - 60,000; 7/1/09 - 50,000; 12/1/09 - 40,000; 3/1/10 - 75,000; 12/1/10 - 50,000; 3/1/11 - 75,000 and 12/1/11 - 50,000. |
| (6) | Represent Holdings Class C restricted stock units, which vest as follows: 7/1/07 - 180,000; 7/1/08 - 225,000 and 7/1/09 - 225,000. |
| (7) | The Company determines the fair value of its Holdings Class C restricted stock units from the probability-weighted expected return method. Under this method, the value of an enterprise’s common stock is estimated from an analysis of the future values for the Company assuming various possible future liquidity events. |
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2006 RESTRICTED STOCK UNIT VESTED TABLE
Name | Number of Restricted Stock Units Vested (1) | Value Realized on Vesting ($) | |||
Dennis G. Dracup | 3,490,909 | $ | 349,091 | ||
Jeffrey C. Grace | 30,000 | $ | 3,000 | ||
Louis F. Provenzano | 150,000 | $ | 15,000 | ||
James L. Moore Jr. | 234,345 | $ | 23,434 | ||
Yung-Chung Heh | 60,000 | $ | 6,000 | ||
Matthew T. Gibbs II | 270,000 | $ | 27,000 | ||
| (1) | Represents Holdings Class C restricted stock units. |
Compensation of Directors
Directors who are officers of, or employed by, the Company or any of its subsidiaries are not additionally compensated for their Board and committee activities. In addition, due to their affiliation with the Company’s principal equityholders, Ms. Koenig, Ms. Nanji and Mr. Brucato are not compensated for their Board activities.
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| ITEM 12: | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT |
Our ultimate parent, Language Line Holdings, LLC (“Holdings”) indirectly owns 100% of our capital stock. The following table sets forth certain information with respect to the beneficial ownership of Holdings equity interests as of March 15, 2006, by (i) each person or entity who owns of record or beneficially 5% or more of any class of Holdings voting securities; (ii) each named executive officer and director of Language Line, Inc.; and (iii) all of the directors and named executive officers of Language Line, Inc. as a group. Except as noted below, the address for each of the directors and named executive officers is c/o Language Line, Inc., 1 Lower Ragsdale Drive, Monterey, California 93940.
Name and Address of Beneficial Holder(1) | Number of Voting Equity Interests Beneficially Owned | Percentage of Total Voting Equity Interests Outstanding | |||
Principal Equityholders: | |||||
ABRY Partners IV, L.P. (1) (2) (3) | 116,597,073 | 83.5 | % | ||
ABRY Mezzanine Partners, L.P. (1) (4) | 8,980,395 | 6.4 | % | ||
Executive Officers and Directors: | |||||
Dennis G. Dracup | 2,277,778 | 1.6 | % | ||
Jeffrey C. Grace | 7,775 | * | |||
Louis F. Provenzano | — | — | |||
James L. Moore Jr. | 650,000 | * | |||
Yung-Chung Heh | 118,208 | * | |||
Jeffrey M. Johnson | — | — | |||
Karen Gilhooly | — | — | |||
Peggy Koenig (6) | — | — | |||
C.J. Brucato (5) | — | — | |||
Azra Nanji | — | — | |||
All Executive Officers & Directors as a group (8 persons) | 3,053,761 | 2.2 | % |
| * | Less than 1% |
| (1) | “Beneficial ownership” generally means any person who, directly or indirectly, has or shares voting or investment power with respect to a security or has the right to acquire such power within 60 days. Unless otherwise indicated, we believe that each holder has sole voting and investment power with regard to the equity interests listed as beneficially owned. |
| (2) | Royce Yudkoff exercises voting and investment control of the equity interests held by ABRY Partners IV, L.P. and ABRY Mezzanine Partners, L.P. The address of both is 111 Huntington Avenue, 30th Floor, Boston, MA 02199. |
| (3) | Royce Yudkoff is the sole member of ABRY Capital Partners, LLC which is the sole general partner of ABRY Capital Partners, L.P. which is the sole general partner of ABRY Partners IV, L.P. |
| (4) | Royce Yudkoff is the sole member of ABRY Mezzanine Holdings, LLC which is the sole general partner of ABRY Mezzanine Investors, L.P. which is the sole general partner of ABRY Mezzanine Partners, L.P. |
| (5) | Mr. Brucato is a limited partner of ABRY Capital Partners, L.P., the sole general partner of ABRY Partners IV, L.P., and ABRY Mezzanine Investors, L.P., the sole general partner of ABRY Mezzanine Partners, L.P. and disclaims beneficial ownership of any equity interests held by either entity. Mr. Brucato’s address is c/o ABRY Partners IV, L.P., 111 Huntington Avenue, 30th Floor, Boston, MA 02199. |
| (6) | Ms. Koenig is a limited partner of ABRY Capital Partners, L.P., the sole general partner of ABRY Partners IV, L.P., and ABRY Mezzanine Investors, L.P., the sole general partner of ABRY Mezzanine Partners, L.P. and disclaims beneficial ownership of any equity interests held by either entity. Ms. Koenig’s address is c/o ABRY Partners IV, L.P., 111 Huntington Avenue, 30th Floor, Boston, MA 02199. |
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| ITEM 13: | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE |
Members Agreement
In connection with the Merger, the members of Holdings entered into a Members Agreement. Pursuant to the Members Agreement, such members agreed to vote their equity interests in Holdings so that the following directors are elected to the board of managers of Holdings: (i) three directors designated by ABRY Partners IV, L.P., (ii) the then current chief executive officer of Holdings, who shall initially be Dennis G. Dracup and (iii) the then current chief financial officer of Holdings, who shall initially be Matthew T. Gibbs II. The Members Agreement also contains:
| • | “tag-along” sale rights exercisable by all investors in the event of sales of equity interests by ABRY Partners, LLC to unaffiliated third parties; |
| • | “drag-along” sale rights exercisable by the board of managers of Holdings and holders of a majority of the then outstanding voting equity interests in the event of an Approved Sale, as defined in the Members Agreement; |
| • | preemptive rights; and |
| • | restrictions on transfers of membership interests by management and other key employees absent written authorization of the Board of Directors, except in certain circumstances. |
During 2006, concurrent with the resignation of the Chief Financial Officer, Matthew T. Gibbs II, Mr. Grace was appointed the Company’s new Chief Financial Officer, and also replaced Mr. Gibbs director role. In addition, during 2006 Louis F. Provenzano was designated a director.
The voting restrictions and tag-along, drag-along and transfer restrictions will terminate upon consummation of the first to occur of a Qualified Public Offering, as defined in the Members Agreement, or an Approved Sale.
Indemnification
Holdings’ Amended and Restated Limited Liability Company Agreement, dated as of June 11, 2004, provides for indemnification of directors and officers, including advancement of reasonable attorney’s fees and other expenses, in connection with all claims, liabilities and expenses arising out of the management of Holdings affairs. Such indemnification obligations are limited to the extent that Holdings assets are sufficient to cover such obligations. Holdings carries directors and officers insurance that covers such exposure for indemnification up to certain limits. While Holdings may be subject to various proceedings in the ordinary course of business that involve claims against directors and officers, we believe that such claims are routine in nature and incidental to the conduct of Holdings business. None of such claims, if determined adversely against such directors and officers, would have a material adverse effect on Holdings consolidated financial condition or results of operations. As of the closing of the Merger, Holdings had not accrued any amounts to cover indemnification obligations arising from such claims.
Loans
In 2001, the Predecessor loaned $995,000 to an officer in exchange for a note receivable (“Note A”). Note A was collateralized by the officer’s primary residence. In 2002, the Predecessor loaned $100,000 to another officer in exchange for a note receivable (“Note B”). Note B is collateralized by Holdings common stock. In connection with the Merger, which occurred on June 11, 2004, both of these loans were modified to extend their maturities. These modifications were made when LLI was a private company not subject to the Sarbanes-Oxley Act of 2002 (the “Act”). In September, 2004, LLI became subject to the Act and as a result the loans may not have been compliant with the Act. To address this matter, on April 13, 2005, $1,095,000 was distributed from LLI in the form of a dividend to its parent, LLHI. LLHI then distributed in the form of a dividend that same amount to its parent, Language Line Holdings III, Inc. (the “Parent”). Parent then made new loans to the executives in the same amount as the loans held by LLI. The loans held by LLI were simultaneously repaid in full by the officers. Each of the dividends and loans mentioned above that occurred on April 13, 2005 were affected in non-cash transactions. This action required a waiver from the lenders party to LLI’s credit agreement, which was obtained on April 13, 2005. On May 18, 2005, a capital contribution in the amount of $995,000 was made by the Parent to LLHI when the one officer liable for Note A repaid his loan to the Parent.
33
Registration Rights Agreement
In connection with the Merger, the members of Language Line Holdings, LLC entered into a Registration Rights Agreement. Pursuant to the Registration Rights Agreement, the holders of a majority of the Investor Registrable Securities, as defined therein, have the ability to cause us to register securities of the Company held by parties to the Registration Rights Agreement and to participate in registrations by us of our Registrable Securities, as defined in the Registration Rights Agreement. All holders of Registrable Securities are subject to customary lock-up arrangements in connection with public offerings.
Reimbursement Agreement
In connection with the Merger, we entered into a Reimbursement Agreement. Pursuant to the Reimbursement Agreement, we agreed to reimburse ABRY for all out-of-pocket expenses incurred in connection with the Merger and related transactions or their ownership of equity interests of Language Line Holdings, LLC.
Transactions
On January 19, 2006 our ultimate parent completed its acquisition of the previously unaffiliated U.K. based Language Line, Limited (“Language Line UK”). Language Line UK’s business operations results are independent of the Company. Transactions such as administrative and sales support services between the Company and Language Line UK started on January 20, 2006. The Company believes that the terms and nature of the transactions are no less favorable than those available with unrelated parties.
Board of Directors
The board is currently composed of six directors, none of whom is likely to qualify as an independent director based on the definition of independent director set forth in Rule 4200(a)(15) of the Nasdaq Marketplace rules. Because affiliates of ABRY own more than 50% of the voting common stock of Holdings, we would be a “controlled company” within the meaning of Rule 4350(c)(5) of the Nasdaq Marketplace rules, which would qualify us for exemptions from certain corporate governance rules of The Nasdaq Stock Market LLC, including the requirement that the board of directors be composed of a majority of independent directors.
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| ITEM 14: | PRINCIPAL ACCOUNTANT FEES AND SERVICES |
During the fiscal years ended December 31, 2006 and December 31, 2005, fees for services provided by PricewaterhouseCoopers LLP and Deloitte & Touche LLP, were as follows (in thousands):
| Year Ended December 31, | ||||||
| 2006 | 2005 | |||||
Audit Fees | $ | 743 | $ | 528 | ||
Audit-Related Fees | 38 | 3 | ||||
Tax Fees | 295 | 384 | ||||
Total | $ | 1,076 | $ | 915 | ||
“Audit Fees” consisted of fees billed for services rendered for the audit of our Company’s annual financial statements, review of financial statements included in our Company’s quarterly reports on Form 10-Q, and other services normally provided in connection with statutory and regulatory filings. “Audit-Related Fees” consisted of fees billed for due diligence procedures in connection with acquisitions, restructuring and consultation regarding financial accounting and reporting matters. “Tax Fees” consisted of fees billed for tax payment planning and tax preparation services.
Audit Committee Pre-Approval Policy
Our Board has a separately-designated standing Audit Committee. The members of the Audit Committee are C.J. Brucato, Peggy Koenig and Azra Nanji. Prior to engaging our principal accountants to render audit or non-audit services, the engagement as well as charges for such services is approved by our Audit Committee.
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ITEM 15: EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) The following documents are filed as part of this Annual Report on Form 10-K.
1. Consolidated Financial Statements:
| Page | ||
| 38 | ||
| 39 | ||
| 40 | ||
| 41 | ||
| 42 | ||
| 43 | ||
| 44 |
2. Financial Statement Schedule:
| Page | ||
| 59 |
All other schedules have been omitted because the information required to be set forth therein is not applicable or is shown in the financial statements or notes thereto.
3. Exhibits
| 3.1 | Certification of Incorporation of Language Line Holdings, Inc. (f/k/a Language Line Acquisition, Inc.).* | |
| 3.2 | By-Laws of Language Line Holdings, Inc. (f/k/a Language Line Acquisition, Inc.).* | |
| 4.1 | Indenture, dated as of June 11, 2004 among Language Line Holdings, Inc. (f/k/a Language Line Acquisition, Inc.) and The bank of New York.* | |
| 4.2 | Registration Rights Agreement, dated as of June 11, 2004, by and among Language Line Holdings, Inc. (f/k/a Language Line acquisition, Inc.), MLPFS and each other Initial Purchases set forth on Schedule B. * | |
| 4.3 | Joinder Agreement, dated June 11, 2004, among Language Line Holdings, Inc., Language Line, LLC, Envok, LLC, On Line Interpreters, Inc., Language Line Services, Inc., Language Line Dominican Republic LLC, Language Line Panama, LLC and Language Line Costa Rica, LLC. * | |
| 4.4 | First Supplemental Indenture, dated as of June 11, 2004, among Language Line, Inc., Language Line, LLC, Envok, LLC, On Line Interpreters, Inc., Language Line Services, Inc., Language Line Dominican Republic LLC, Language Line Panama, LLC, Language Line Costa Rica, LLC, Language Line Holdings, Inc. and the Bank of New York. * | |
| 4.5 | Form of Note (included in Exhibit 4.1). * | |
| 10.1 | Agreement and Plan of Merger, dated April 14, 2004 by and among Language Line Holdings, Inc., Language Line Acquisition, Inc. and Language, Inc. * | |
| 10.2 | Preferred Securities Purchase Agreement, dated as of June 11, 2004 by and among Language Line Holdings, LLC and the purchasers named in the Purchaser Schedule. * | |
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| 10.3 | Registration Rights Agreement, dated June 11, 2004, by and among Language Line Holdings, LLC and the members and Language Line Holdings, LLC’s members. * | |
| 10.4 | Executive Employment Agreement, dated June 11, 2004, by and between Language Line, Inc and Dennis Dracup. * | |
| 10.5 | Executive Employment Agreement, dated June 11, 2004, by and between Language Line, Inc. and Matthew Gibbs. * | |
| 10.6 | Non-competition, Non-solicitation Agreement, dated June 11, 2004, by and among Language Line Acquisition, Inc, Language Line, Inc. and Dennis Dracup. * | |
| 10.7 | Non-competition, Non-solicitation Agreement, dated June 11, 2004, by and among Language Line Acquisition, Inc, Language Line, Inc. and Matthew Gibbs. * | |
| 10.8 | Incentive Securities Agreement, dated June 11, 2004, by and among Language Line Holdings, LLC, Dennis G. Dracup Declaration of Trust and Christine L. Dracup Declaration of Trust. * | |
| 10.9 | Incentive Securities Agreement, dated June 11, 2004, by and between Language Line Holdings, LLC and Matthew Gibbs. * | |
| 10.10 | Incentive Units Agreement, dated July 14, 2004, by and between Language Line Holdings, LLC and Jeanne Anderson. * | |
| 10.11 | Incentive Units Agreement, dated July 14, 2004, by and between Language Line Holdings, LLC and Dennis Bailey. * | |
| 10.12 | Incentive Units Agreement, dated July 14, 2004, by and between Language Line Holdings, LLC and Phil Speciale. * | |
| 10.13 | Investor Securities Purchase Agreement, dated June 11, 2004, by and among Language Line Holdings, LLC and the persons listed on Schedule A. * | |
| 10.14 | Credit Agreement, dated as of June 11, 2004 as amended and restated on November 14, 2006, by and among Language Line, Inc., Language Line Acquisition, Inc., Merrill Lynch & Co. and MLPFS. * | |
| 10.15 | Security Agreement, dated as of June 11, 2004, by and among Language Line, Inc., Language Line Holdings, Inc., the Subsidiary Guarantors party thereto and Merrill Lynch Capital Corporation. * | |
| 10.16 | Guarantee, dated June 11, 2004 by and among Language Line Holdings, Inc. in favor of Merrill Lynch Capital Corporation.* | |
| 10.17 | Trademark Security Agreement, dated as of June 11, 2004 by and among Language Line Inc., each of the Guarantors listed on Schedule II thereto and in favor of Merrill Lynch Capital Corporation. * | |
| 10.18 | Amended and Restated Promissory Note in the principal amount of $100,000 from Matthew T. Gibbs II and Kathy Gibbs in favor of Language Line, Inc., dated June 11, 2004. * | |
| 10.19 | Amended and Restated Promissory Note in the principal amount of $995,000 from Dennis G. Dracup in favor of Language Line, Inc., dated June 11, 2004. * | |
| 10.20 | Amendment to the Deed of Trust and Assignment of Rents, dated June 11, 2004, by and between Dennis G. Dracup and Christine L. Dracup as “Trustor,” in favor of Old Republic Title Company as trustee in trust for Language Line, Inc. * | |
| 10.21 | Amended and Restated Unit Pledge Agreement, dated June 1, 2004 by and between Language Line, Inc., Matthew T. Gibbs, II and Kathy Gibbs. * | |
| 10.22 | Intercompany Services Agreement, dated January 19, 2006 between Language Line, LLC and Language Line Ltd. *** | |
| 10.23 | Release between Language Line, Inc. and Matthew Gibbs dated December 8, 2006 (incorporated by reference to the Company’s Annual Report on Form 10-K, filed on December 11, 2006). | |
| 10.24 | Repurchase Notice by Language Line Holdings, LLC to Matthew Gibbs dated December 11, 2006 (incorporated by reference to the Company’s Annual Report on Form 10-K, filed on December 11, 2006). | |
| 10.25 | Offer Letter to Jeffrey Grace dated December 8, 2006 (incorporated by reference to the Company’s Annual Report on Form 10-K, filed on December 11, 2006). | |
| 12.1 | Statement regarding computation of ratio of earnings to fixed charges. * * | |
| 14.1 | Code of Business Conduct and Ethics. *** | |
| 21.1 | Subsidiaries of Language Line Holdings, Inc. * | |
| 31.1 | Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. ** | |
| 31.2 | Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. ** | |
| 32.1 | Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. ** | |
| 32.2 | Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. ** | |
| * | Incorporated by reference to the Registration Statement on Form S-4 (File No. 333-118754). |
| ** | Filed herewith. |
| *** | Incorporated by reference to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2005. |
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of Language Line Holdings, Inc.:
In our opinion, the accompanying consolidated financial statements listed in the index appearing under Item 15(a)(1) present fairly, in all material respects, the financial position of Language Line Holdings, Inc. and subsidiaries at December 31, 2006, and the results of their operations and their cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the index appearing in Item 15(a)(2) presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audit. We conducted our audit of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
As discussed in Note 7 to the consolidated financial statements, in 2006 the Company adopted a new accounting standard that required it to change the manner in which it accounts for share-based compensation.
PricewaterhouseCoopers LLP
San Francisco, CA
March 16, 2007
38
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of Language Line Holdings, Inc.:
We have audited the accompanying consolidated balance sheet of Language Line Holdings, Inc. and subsidiaries (LLHI”) as of December 31, 2005, and the related consolidated statements of operations, stockholders’ equity (deficit) and comprehensive income (loss), and cash flows for the period from June 12, 2004 to December 31, 2004 and the year ended December 31, 2005. We have also audited the accompanying consolidated statements of operations, stockholders’ equity (deficit) and comprehensive income (loss), and cash flows of the predecessor company to LLHI (also named Language Line Holdings, Inc.) and its subsidiaries (“Predecessor”) for the period from January 1, 2004 to June 11, 2004 (date of disposition). Our audits also included the financial statement schedule for the period from January 1, 2004 to June 11, 2004; period from June 12, 2004 to December 31, 2004; and year ended December 31, 2005, listed in the Index at Item 15. These financial statements and the financial statement schedule are the responsibility of management. Our responsibility is to express an opinion on the financial statements and the financial statement schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. Neither LLI nor Predecessor is required to have, nor were we engaged to perform, an audit of their internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis of designing audit procedures that are appropriate in the circumstances but not for the purpose of expressing an opinion on the effectiveness of LLI’s or Predecessor’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of LLHI as of December 31, 2005, and the results of its operations and its cash flows for the period from June 12, 2004 to December 31, 2004 and the year ended December 31, 2005, and Predecessor’s results of operations and cash flows for the period from January 1, 2004 to June 11, 2004 in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule for the period from January 1, 2004 to June 11, 2004; period from June 12, 2004 to December 31, 2004; and year ended December 31, 2005, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
/s/ DELOITTE & TOUCHE LLP
San Jose, California
April 11, 2006
39
LANGUAGE LINE HOLDINGS, INC. AND SUBSIDIARIES
(An Indirect Wholly-Owned Subsidiary of Language Line Holdings, LLC)
Consolidated Balance Sheets
(In thousands, except share and par value amounts)
| December 31, | ||||||||
| 2006 | 2005 | |||||||
Assets | ||||||||
Current assets: | ||||||||
Cash and cash equivalents | $ | 20,236 | $ | 13,991 | ||||
Accounts receivable - net of allowance for doubtful accounts of $1,503 in 2006 and $738 in 2005 | 24,321 | 22,329 | ||||||
Prepaid expenses and other current assets | 1,461 | 2,681 | ||||||
Deferred taxes on income | 1,013 | 621 | ||||||
Total current assets | 47,031 | 39,622 | ||||||
Property and equipment, net | 5,385 | 4,991 | ||||||
Goodwill | 408,793 | 408,793 | ||||||
Intangible assets - net of accumulated amortization of $90,961 in 2006 and $57,044 in 2005 | 369,139 | 403,056 | ||||||
Deferred financing costs - net of accumulated amortization of $5,556 in 2006 and $3,312 in 2005 | 13,253 | 13,173 | ||||||
Other assets | 365 | 96 | ||||||
Total assets | $ | 843,966 | $ | 869,731 | ||||
Liabilities and Stockholders’ Equity | ||||||||
Current liabilities | ||||||||
Accounts payable | $ | 2,351 | $ | 1,208 | ||||
Accrued interest | 3,485 | 4,848 | ||||||
Accrued payroll and related benefits | 2,339 | 817 | ||||||
Accrued cost of interpreters | 675 | 1,288 | ||||||
Other accrued liabilities | 2,325 | 1,786 | ||||||
Income taxes payable | 3,008 | 2,341 | ||||||
Current portion of long-term debt | 17,251 | 18,638 | ||||||
Total current liabilities | 31,434 | 30,926 | ||||||
Long-term debt | 219,181 | 236,431 | ||||||
Senior subordinated notes | 161,725 | 161,315 | ||||||
Senior discount notes | 77,940 | 67,996 | ||||||
Deferred taxes on income | 149,403 | 159,643 | ||||||
Total liabilities | 639,683 | 656,311 | ||||||
Stockholders’ equity | ||||||||
Common stock, $.01 par value per share and 1,000 shares authorized, issued and outstanding | — | — | ||||||
Additional paid-in capital | 227,137 | 228,015 | ||||||
Accumulated deficit | (22,854 | ) | (13,343 | ) | ||||
Deferred stock compensation | — | (1,252 | ) | |||||
Total stockholders’ equity | 204,283 | 213,420 | ||||||
Total liabilities and stockholders’ equity | $ | 843,966 | $ | 869,731 | ||||
See notes to consolidated financial statements.
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LANGUAGE LINE HOLDINGS, INC. AND SUBSIDIARIES
(An Indirect Wholly-Owned Subsidiary of Language Line Holdings, LLC)
Consolidated Statements of Operations
(In thousands)
| Predecessor | |||||||||||||||
Year Ended December 31, 2006 | Year Ended December 31, 2005 | June 12, 2004 to December 31, 2004 | January 1, 2004 to June 11, 2004 | ||||||||||||
Revenues | $ | 163,294 | $ | 144,878 | $ | 80,284 | $ | 64,692 | |||||||
Costs of services | 57,832 | 49,275 | 25,973 | 21,512 | |||||||||||
Other expenses: | |||||||||||||||
Selling, general and administrative | 28,891 | 24,635 | 12,441 | 10,423 | |||||||||||
Interest | 54,161 | 50,117 | 25,685 | 6,031 | |||||||||||
Merger related expenses | — | — | 104 | 9,848 | |||||||||||
Depreciation and amortization | 36,409 | 39,217 | 21,709 | 1,735 | |||||||||||
Total other expenses | 119,461 | 113,969 | 59,939 | 28,037 | |||||||||||
Other income: | |||||||||||||||
Interest | 798 | 285 | 287 | 49 | |||||||||||
Escrow settlement | 795 | — | — | — | |||||||||||
Total other income | 1,593 | 285 | 287 | 49 | |||||||||||
Income (loss) before income taxes | (12,406 | ) | (18,081 | ) | (5,341 | ) | 15,192 | ||||||||
Income tax provision (benefit) | (2,895 | ) | (8,465 | ) | (1,614 | ) | 5,968 | ||||||||
Net income (loss) | $ | (9,511 | ) | $ | (9,616 | ) | $ | (3,727 | ) | $ | 9,224 | ||||
See notes to consolidated financial statements.
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LANGUAGE LINE HOLDINGS, INC. AND SUBSIDIARIES
(An Indirect Wholly-Owned Subsidiary of Language Line Holdings, LLC)
Consolidated Statements of Stockholders’ Equity (Deficit) and Comprehensive Income (Loss)
(In thousands except share amounts)
| Common Stock | Treasury Stock | ||||||||||||||||||||||||||||||
| Shares | Amount | Additional Paid-in Capital | Accumulated Deficit | Deferred Stock Compensation | Shares | Amount | Total Stockholders’ Equity (Deficit) | Comprehensive Income (Loss) | |||||||||||||||||||||||
BALANCES, January 1, 2004 | 983,200 | $ | 1 | $ | 6,414 | $ | (12,741 | ) | $ | — | 21,450 | $ | (252 | ) | $ | (6,578 | ) | ||||||||||||||
Tax benefit from stock options exercised | — | — | 6,094 | — | — | — | — | 6,094 | |||||||||||||||||||||||
Net income thru June 11, 2004 | — | — | — | 9,224 | — | — | — | 9,224 | $ | 9,224 | |||||||||||||||||||||
PREDECESSOR ENDING BALANCES, June 11, 2004 | 983,200 | 1 | 12,508 | (3,517 | ) | — | 21,450 | (252 | ) | 8,740 | |||||||||||||||||||||
Beginning balance, June 12, 2004 | — | — | — | — | — | — | — | — | |||||||||||||||||||||||
Issuance of common stock | 1,000 | — | 226,289 | — | — | — | — | 226,289 | |||||||||||||||||||||||
Issuance of grant of parent’s class C common shares to employees | — | — | 1,869 | — | (1,869 | ) | — | — | — | ||||||||||||||||||||||
Amortization of deferred stock compensation | — | — | — | — | 208 | — | — | 208 | |||||||||||||||||||||||
Net loss from June 12, 2004 to December 31, 2004 | — | — | — | (3,727 | ) | — | — | — | (3,727 | ) | (3,727 | ) | |||||||||||||||||||
BALANCES, December 31, 2004 | 1,000 | — | 228,158 | (3,727 | ) | (1,661 | ) | — | — | 222,770 | |||||||||||||||||||||
Dividend distribution to Parent | — | — | (1,095 | ) | — | — | — | — | (1,095 | ) | |||||||||||||||||||||
Capital contribution from Parent | — | — | 995 | — | — | — | — | 995 | |||||||||||||||||||||||
Repurchase of class C common shares from employees | — | — | (43 | ) | — | 43 | — | — | — | ||||||||||||||||||||||
Amortization of deferred stock compensation | — | — | — | — | 366 | — | — | 366 | |||||||||||||||||||||||
Net loss | — | — | — | (9,616 | ) | — | — | — | (9,616 | ) | (9,616 | ) | |||||||||||||||||||
BALANCES, December 31, 2005 | 1,000 | — | 228,015 | (13,343 | ) | (1,252 | ) | — | — | 213,420 | |||||||||||||||||||||
Repurchase of class C common shares from employee | — | — | (41 | ) | — | — | — | — | (41 | ) | |||||||||||||||||||||
Amortization of deferred stock compensation | — | — | 415 | — | — | — | — | 415 | |||||||||||||||||||||||
Adoption of SFAS 123R | — | — | (1,252 | ) | — | 1,252 | — | — | — | ||||||||||||||||||||||
Net loss | — | — | (9,511 | ) | — | — | — | (9,511 | ) | $ | (9,511 | ) | |||||||||||||||||||
BALANCES, December 31, 2006 | 1,000 | $ | — | $ | 227,137 | $ | (22,854 | ) | $ | — | — | $ | — | $ | 204,283 | ||||||||||||||||
See notes to consolidated financial statements.
42
LANGUAGE LINE HOLDINGS, INC. AND SUBSIDIARIES
(An Indirect Wholly-Owned Subsidiary of Language Line Holdings, LLC)
Consolidated Statements of Cash Flows
(In thousands)
| Predecessor | ||||||||||||||||
| Year Ended December 31, 2006 | Year Ended December 31, 2005 | June 12, 2004 to December 31, 2004 | January 1, 2004 to June 11, 2004 | |||||||||||||
Cash flows from operating activities: | ||||||||||||||||
Net income (loss) | $ | (9,511 | ) | $ | (9,616 | ) | $ | (3,727 | ) | $ | 9,224 | |||||
Adjustments to reconcile net income (loss) to net cash provided by operating activities: | ||||||||||||||||
Depreciation and amortization | 36,408 | 39,217 | 21,709 | 1,735 | ||||||||||||
Amortization of deferred financing costs | 2,244 | 2,136 | 1,176 | 1,225 | ||||||||||||
Deferred taxes on income | (10,632 | ) | (13,902 | ) | (6,213 | ) | 1,300 | |||||||||
Provision for losses on accounts receivable | 1,254 | 435 | 123 | 38 | ||||||||||||
Stock based compensation expense | 415 | 366 | 208 | — | ||||||||||||
Tax benefit from stock options exercised | — | — | — | 6,094 | ||||||||||||
Loss on disposal of property | — | 9 | — | 19 | ||||||||||||
Loss (gain) from derivative instruments | — | 4 | 35 | (1,886 | ) | |||||||||||
Write-off of deferred financing costs | — | — | — | 9,555 | ||||||||||||
Accretion of discount on long-term debt | 10,354 | 9,043 | 4,509 | — | ||||||||||||
Effect of changes in operating assets and liabilities: | ||||||||||||||||
Accounts receivable | (3,246 | ) | (3,138 | ) | 1,517 | 297 | ||||||||||
Prepaid expenses and other current assets | 1,220 | (1,025 | ) | 390 | (150 | ) | ||||||||||
Other assets | (269 | ) | 137 | (86 | ) | (25 | ) | |||||||||
Accounts payable | 1,143 | 746 | 254 | (450 | ) | |||||||||||
Income taxes payable | 667 | (110 | ) | 7,204 | (5,495 | ) | ||||||||||
Accrued interest and other liabilities | 86 | 2,710 | (863 | ) | (1,457 | ) | ||||||||||
Net cash provided by operating activities | 30,133 | 27,012 | 26,236 | 20,024 | ||||||||||||
Cash flows from investing activities: | ||||||||||||||||
Purchases of property | (2,885 | ) | (1,584 | ) | (1,160 | ) | (860 | ) | ||||||||
Acquisition of Predecessor, net of cash acquired | — | — | (716,224 | ) | — | |||||||||||
Notes receivable collections | — | — | 39 | — | ||||||||||||
Net cash used in investing activities | (2,885 | ) | (1,584 | ) | (717,345 | ) | (860 | ) | ||||||||
Cash flows from financing activities: | ||||||||||||||||
Long-term debt borrowings | — | — | 507,500 | — | ||||||||||||
Long-term debt repayments | (18,637 | ) | (24,305 | ) | (14,286 | ) | (12,260 | ) | ||||||||
Loan fees and other financing costs | (2,324 | ) | (291 | ) | (16,192 | ) | — | |||||||||
Purchase of derivative instruments | — | — | (38 | ) | — | |||||||||||
Repurchase of restricted stock units | (42 | ) | — | — | — | |||||||||||
Proceeds from issurance of common stock | — | — | 226,289 | — | ||||||||||||
Capital contribution from Parent | — | 995 | — | — | ||||||||||||
Net cash provided by (used in) financing activities | (21,003 | ) | (23,601 | ) | 703,273 | (12,260 | ) | |||||||||
Net increase in cash and cash equivalents | 6,245 | 1,827 | 12,164 | 6,904 | ||||||||||||
Cash and cash equivalents - beginning of period | 13,991 | 12,164 | — | 4,571 | ||||||||||||
Cash and cash equivalents - end of period | $ | 20,236 | $ | 13,991 | $ | 12,164 | $ | 11,475 | ||||||||
Additional cash flow information: | ||||||||||||||||
Cash paid for interest | $ | 42,611 | $ | 35,343 | $ | 18,825 | $ | 7,177 | ||||||||
Cash paid (refunded) for income taxes | $ | 7,070 | $ | 5,549 | $ | (2,615 | ) | $ | 4,069 | |||||||
Non-cash dividend distribution | $ | — | $ | 1,095 | $ | — | $ | — | ||||||||
See notes to consolidated financial statements.
43
Notes to Consolidated Financial Statements
1. Organization and Summary of Significant Accounting Policies
Organization—Language Line Holdings, Inc. (the “Predecessor”) was a Delaware corporation formed in December 1999 as a holding company for Language Line, LLC (“LLC”) and its subsidiaries. LLC was incorporated during February 1999 as a Delaware limited liability company. The Predecessor was acquired on June 11, 2004 by Language Line, Inc. (“LLI”) in a transaction accounted for under the purchase method of accounting (the “Merger”). LLI, a wholly-owned subsidiary of Language Line Acquisition, Inc., is a Delaware corporation formed in April 2004. LLI had no significant operations prior to the acquisition of Predecessor. Subsequent to the Merger, Language Line Acquisition, Inc., an indirect wholly-owned subsidiary of Language Line Holdings, LLC (“Holdings”), was renamed Language Line Holdings, Inc. (“LLHI”, the “Registrant”, or the “Company”).
The Company provides over-the-phone interpretation services, from English into over 150 different languages, 24 hours a day, seven days a week. Such services are provided mainly to the non-English speaking business population in the U.S. and Canada covering various industries such as insurance, healthcare, financial, utilities and government, providing a cost effective alternative to staffing in-house multilingual capabilities or using face-to-face interpretation.
Principles of Consolidation—The consolidated financial statements include the accounts of the Predecessor, LLC and LLC’s wholly-owned subsidiaries for the period from January 1, 2004 to June 11, 2004, and the accounts of LLHI, LLI, LLC and LLC’s wholly-owned subsidiaries for the period from June 12, 2004 to December 31, 2004, and for the years ended December 31, 2005 and December 31, 2006. All significant intercompany accounts and transactions have been eliminated in consolidation.
Fiscal Year—The Company’s fiscal year end is December 31.
Cash equivalents—Cash equivalents are short-term, highly liquid investments with original or remaining maturities of three months or less when purchased.
Reclassification—Interest income and expense have been reclassified to be presented on a gross basis for the periods ended December 31, 2005, December 31, 2004 and June 11, 2004 to conform to the 2006 presentation.
Concentration of Credit Risk—Financial instruments which potentially subject the Company to concentrations of credit risk consist of cash and accounts receivable. Risks associated with cash are mitigated by banking with creditworthy institutions. Concentration of credit risk with respect to trade receivables is limited due to the significant number of customers and their geographic dispersion. During fiscal 2006, 2005 and 2004, no customer represented more than 10% of revenues or accounts receivable. Accounts receivable are generally unsecured.
Property and equipment—The useful life for property and equipment is within the following range:
Useful Lives | ||
Equipment | 1-5 years | |
Software | 1-3 years | |
Furniture and fixtures | 1-5 years | |
Leasehold improvements | The shorter of useful life or initial term of lease |
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As required by SOP 98-1, the Company capitalizes the costs for software developed in-house. Computer software developed or obtained for internal use is amortized using the straight-line method over the estimated useful life of the software, generally three years or less.
Long Lived Assets—The Company follows, and the Predecessor followed Statement of Financial Accounting Standards (“SFAS”) No. 144,Accounting for the Impairment or Disposal of Long-Lived Assets. The Company has assessed the recoverability of long-lived assets, including intangible assets other than goodwill, by determining whether the carrying value of such assets will be recovered through undiscounted future cash flows according to the guidance of SFAS No. 144. The Company assesses whether it will recognize the future benefit of long-lived assets including intangibles in accordance with the provisions of SFAS No. 144. For assets to be held and used, including acquired intangibles, the Company initiates its review whenever events or changes in circumstances indicate that the carrying amount of a long-lived asset may not be recoverable. Recoverability of an asset is measured by comparison of its carrying amount to the expected future undiscounted cash flows (without interest charges) that the asset is expected to generate. Any impairment to be recognized is measured by the amount by which the carrying amount of the asset exceeds its fair value. Significant management judgment is required in the forecasting of future operating results which are used in the preparation of projected discounted cash flows and should different conditions prevail, material write downs of net intangible assets and/or goodwill could occur.
Goodwill and Other Intangible Assets—The Company accounts for goodwill and other intangible assets in accordance with SFAS No. 142,Goodwill and Other Intangible Assets. This statement requires that goodwill resulting from a business combination be tested for impairment annually at the reporting unit level.
The Company tests the impairment of its goodwill annually or whenever events or changes in circumstances indicate that goodwill might be impaired. The Company and the Predecessor completed the annual tests of impairment for goodwill as of October 1, 2006, 2005 and 2004, respectively. These tests resulted in no impairment being recognized.
Deferred financing costs—The Company amortizes deferred financing costs using the straight-line method over the terms of the related debt agreements and the corresponding amortization expense is included in interest expense on the accompanying consolidated statements of operations. In connection with the Merger on June 11, 2004, the Predecessor expensed its outstanding deferred financing costs of $9.6 million and presented the amount as Merger related expenses in the accompanying consolidated statements of operations for the period from January 1, 2004 through June 11, 2004.
Revenues—We recognize revenue when all of the following four revenue recognition criteria have been met:
| • | Persuasive evidence of an arrangement exists, |
| • | The service has been rendered |
| • | The price is fixed or determinable |
| • | Collection is reasonably assured. |
Revenue from interpretation services are recognized as interpretation services are performed based on actual time that is tracked for each call at the negotiated rate per minute for the customer.
Foreign Currency—The functional currency of the foreign subsidiaries is the U.S. Dollar. Transaction and remeasurement gains and losses were not significant for the periods presented. The Predecessor and Company also perform services for Canadian and United Kingdom customers which are billed in local currencies. Transaction gains and losses are reported in the statement of operations as they are incurred. During 2004, 2005 and 2006 such gains and losses were not significant and are included in other expenses.
Costs of services—These costs are primarily direct costs of personnel serving as interpreters, answer points and telecommunications expenses for long-distance calls related to providing service to customers. Answer point costs are related to the personnel that receive incoming calls from customers.
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Income Taxes—Income taxes are accounted for using an asset and liability approach. Deferred income taxes reflect the net effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes, and operating loss and tax credit carryforwards measured by applying currently enacted tax laws. A valuation allowance is provided to reduce net deferred tax assets to an amount that is more likely than not to be realized.
Stock-Based Compensation—We account for stock-based compensation in accordance with Statement of Financial Accounting Standards (SFAS) No. 123(R), “Share Based Payment”. Under SFAS 123(R), the Company determines the fair value of its Holdings Class C restricted stock units from the probability-weighted expected return method. Under this method, the value of an enterprise’s common stock is estimated from an analysis of the future values for the Company assuming various possible future liquidity events. SFAS 123(R) requires that the Company recognize compensation expense for only the portion of restricted stock units that are expected to vest, rather than recording forfeitures when they occur, as previously permitted. If the actual number of forfeitures differs from those estimated by management, additional adjustments to compensation expense may be required in future periods. The following table illustrates the effect on net income if the Predecessor and the Company had applied the fair value recognition provisions of SFAS No. 123 and in accordance with SFAS No. 148,Accounting of Stock-Based Compensation – Transition and Disclosure, An Amendment of FASB Statement No. 123, to stock-based employee compensation (in thousands):
| Predecessor | ||||||||||||
| Year Ended December 31, 2005 | June 12, 2004 to December 31, 2004 | January 1, 2004 to June 11, 2004 | ||||||||||
Net income (loss), as reported | $ | (9,616 | ) | $ | (3,727 | ) | $ | 9,224 | ||||
Add total stock-based employee compensation expense included in reported net income (loss), net of related tax effects | 237 | 127 | — | |||||||||
Deduct total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects | (237 | ) | (127 | ) | (101 | ) | ||||||
Pro forma net income (loss) | $ | (9,616 | ) | $ | (3,727 | ) | $ | 9,123 | ||||
Fair Value of Financial Instruments—The carrying amount for cash, accounts receivable, accounts payable and employee notes receivable approximated fair value at December 31, 2006 and 2005. The fair value of debt instruments is disclosed in Note 4. The fair value of the derivative financial instruments is based on dealer quotes, considering current interest rates, and represents the estimated receipts or payments that would be made to terminate the agreements.
Derivatives—The Company’s derivative contracts, whether designated in hedging relationships or not, are recorded on the balance sheet at fair value. These contracts are cap agreements entered into in order to manage the Company’s exposure to interest rate movements. The Predecessor’s interest rate swaps and caps convert a portion of its variable rate debt to a fixed rate of interest. No derivative contracts have been designated as hedging and, as a result, changes in the fair value of the contracts during a period are recognized immediately in earnings as a component of interest expense.
The value of the derivative contracts liability (asset) and the changes in value are as follows (in thousands):
| Predecessor | |||||||||||||||
| Year Ended December 31, 2006 | Year Ended December 31, 2005 | June 12, 2004 to December 31, 2004 | January 1, 2004 to June 11, 2004 | ||||||||||||
Beginning balance - derivative contracts liability (asset) - net | $ | — | $ | (4 | ) | $ | — | $ | 3,023 | ||||||
Purchase of interest rate cap contracts | — | — | (38 | ) | — | ||||||||||
Increase (decrease) in fair value of net liabilities (assets) during the period | — | 4 | 34 | (1,886 | ) | ||||||||||
Ending balance - derivative contracts liability (asset) - net | $ | — | $ | — | $ | (4 | ) | $ | 1,137 | ||||||
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Use of Estimates in the Preparation of Financial Statements—The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. Such management estimates include the allowance for doubtful accounts receivables, the useful life of goodwill and intangible assets and certain other accrued liabilities and income taxes. Actual results could differ from those estimates.
Recently Issued Accounting Pronouncements—We adopted Statement of Financial Accounting Standards (SFAS) No. 123(R), “Share Based Payment” as of January 1, 2006. Under SFAS 123(R), the Company determines the fair value of its restricted stock units from the probability-weighted expected return method. Under this method, the value of an enterprise’s common stock is estimated from an analysis of the future values for the Company assuming various possible future liquidity events. SFAS 123(R) requires that the Company recognize compensation expense for only the portion of restricted stock units that are expected to vest, rather than recording forfeitures when they occur, as previously permitted. If the actual number of forfeitures differs from those estimated by management, additional adjustments to compensation expense may be required in future periods.
In June 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48 prescribes guidance for the recognition and measurement of a tax position taken or expected to be taken in a tax return. Recognition of an asset or liability is required if it is more likely than not that a tax position will be sustained upon examination, including resolution of any related appeals or litigation processes. The provisions of FIN 48 are effective for us on January 1, 2007, with the cumulative effect of the change in accounting principle, if any, recorded as an adjustment to opening retained earnings. We anticipate the effect to our balance sheet as of January 1, 2007 to be immaterial.
In September 2006, the FASB issued SFAS No. 157 (“SFAS 157”) “Fair Value Measurements,” which defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS 157 applies to other accounting pronouncements that require or permit fair value measurements. It is effective for us beginning in fiscal year 2008. We are currently evaluating the impact of adopting SFAS 157.
On February 15, 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (FAS 159). This Statement is a fair value option for financial assets and financial liabilities and includes an amendment of FASB Statement No. 115 which covers accounting for certain investments in debt and equity securities. It is effective for us beginning in fiscal year 2008. We are currently evaluating the impact of adopting SFAS 159.
In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin (“SAB”) No. 108,“Considering the Effects of Prior Year Misstatements when Quantifying Current Year Misstatements” (“SAB 108”). SAB 108 requires analysis of misstatements using both an income statement (rollover) approach and a balance sheet (iron curtain) approach in assessing materiality, either of which was previously acceptable, and provides for a one-time cumulative effect transition adjustment. We adopted SAB No. 108 on its effective date, December 31, 2006, and it had no effect on our financial statements.
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2. Business Combinations, Escrow Settlement, Goodwill and Intangible Assets
Business Combinations –On June 11, 2004, LLI, an indirect subsidiary of ABRY Partners (“ABRY”) acquired the Predecessor in a transaction accounted for under the purchase method of accounting (the “Merger”). The aggregate purchase price was $718.1 million. The merger agreement contains customary representations and warranties and covenants. At closing, $30.0 million of the Merger consideration was deposited into an escrow account on behalf of the stockholders and optionholders of the Predecessor to secure their potential indemnity obligations to LLI and payment of any post-closing adjustment to the Merger consideration to LLI. Since the Merger, periodic payments from the escrow account have been paid to the stockholders and optionholders of the Predecessor according to a pre-determined payment schedule. Final settlement of the escrow account was reached with the previous owners on July 25, 2006. In final settlement of the escrow account, the Company received $795,000 for potential tax liabilities. As the Company had already recorded these additional tax liabilities subsequent to the Merger and concluded there is not a clear and direct link to the original purchase price, the settlement amount of $795,000 was recorded into other income in the third quarter of 2006.
The following table summarizes the estimated fair values of the assets acquired and liabilities assumed (in thousands).
Purchase Price: | ||||
Cash payment to seller (including $30.0 million escrow deposit) | $ | 493,694 | ||
Payment of Predecessor indebtedness | 223,379 | |||
Acquisition costs | 1,064 | |||
Total purchase price | $ | 718,137 | ||
Net assets acquired: | ||||
Current assets | $ | 31,531 | ||
Furniture and equipment | 6,195 | |||
Identifiable intangible assets | 460,100 | |||
Goodwill | 408,793 | |||
Other assets | 1,271 | |||
Current liabilities | (8,500 | ) | ||
Note payable | (1,793 | ) | ||
Capital lease obligation | (126 | ) | ||
Deferred tax liability | (179,334 | ) | ||
Net assets acquired | $ | 718,137 | ||
The $408.8 million of goodwill is not deductible for income tax purposes.
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Goodwill and Intangible Assets –As of December 31, 2005 and 2006, the Company’s acquired intangible assets are being amortized on a straight-line basis as follows (in thousands):
| December 31, 2006 | December 31, 2005 | |||||||||||||||||||||
| Gross Carrying Amount | Accumulated Amortization | Net Carrying Amount | Weighted Average Amortization Period | Gross Carrying Amount | Accumulated Amortization | Net Carrying Amount | Weighted Average Amortization Period | |||||||||||||||
| (years) | (years) | |||||||||||||||||||||
Customer relationships | 401,400 | 51,234 | 350,166 | 20 | 401,400 | 31,164 | 370,236 | 20 | ||||||||||||||
Trademark and tradename | 34,500 | 17,614 | 16,886 | 5 | 34,500 | 10,714 | 23,786 | 5 | ||||||||||||||
Internally developed software | 14,000 | 11,913 | 2,087 | 3 | 14,000 | 7,247 | 6,753 | 3 | ||||||||||||||
Covenants-not-to-compete | 10,200 | 10,200 | — | 2 | 10,200 | 7,919 | 2,281 | 2 | ||||||||||||||
| $ | 460,100 | $ | 90,961 | $ | 369,139 | 18 | $ | 460,100 | $ | 57,044 | $ | 403,056 | 18 | |||||||||
The expected future amortization of the acquired intangible assets at December 31, 2006 is as follows (in thousands):
| Year Ending December 31 | |||
2007 | $ | 29,057 | |
2008 | 26,970 | ||
2009 | 23,156 | ||
2010 | 20,070 | ||
2011 | 20,070 | ||
Thereafter | 249,816 | ||
Total | $ | 369,139 | |
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3. Property and equipment
Property and equipment consists of the following (in thousands):
| December 31, 2006 | December 31, 2005 | |||||||
Equipment | $ | 7,044 | $ | 5,245 | ||||
Software | 981 | 924 | ||||||
Leasehold improvements | 1,798 | 1,199 | ||||||
Furniture and fixtures | 877 | 556 | ||||||
Subtotal | 10,700 | 7,924 | ||||||
Construction in progress | 109 | — | ||||||
Total | 10,809 | 7,924 | ||||||
Accumulated depreciation and amortization | (5,424 | ) | (2,933 | ) | ||||
Property and equipment- net | $ | 5,385 | $ | 4,991 | ||||
Depreciation and amortization of property and equipment for the year ended December 31, 2006 and for the year ended December 31, 2005, for the period from June 12, 2004 to December 31, 2004, for the period from January 1, 2004 to June 11, 2004 was $2,491,000, $2,480,000, $1,381,000 and $1,116,000, respectively.
4. Long-Term Debt
Long-term debt consists of the following (in thousands):
| December 31, 2006 | December 31, 2005 | |||||
Current portion of long-term debt: | ||||||
Term loan | $ | 17,251 | $ | 17,703 | ||
Notes payable to others | — | 917 | ||||
Capital lease obligations | — | 18 | ||||
| 17,251 | 18,638 | |||||
Long-term debt (non-current): | ||||||
Term loan | 219,181 | 236,431 | ||||
Senior subordinated notes | 161,725 | 161,315 | ||||
Senior discount notes | 77,940 | 67,996 | ||||
Total debt | $ | 476,097 | $ | 484,380 | ||
As of December 31, 2004 the Company originally had a $40.0 million reducing revolver credit facility and a $277.5 million term loan under a bank loan agreement dated June 11, 2004 (the “2004 Loans”). The reducing revolver credit facility is due June 11, 2010 and the term loan is due June 10, 2011. Under the terms of the loan agreement, the Company may elect either a variable rate of interest (equal to the lender’s “base rate” plus an applicable margin) or an interest rate fixed for a specified period of one, two, three or six months (equal to LIBOR plus an applicable margin) for the revolver and one, two, or three months for the term loan. The applicable margins used to calculate these interest rates are determined based on the Company’s ratio of total debt less excess cash to earnings before interest, taxes, depreciation and amortization (“EBITDA”), as defined in the loan agreements. The senior credit facilities are collateralized by first priority interests in, and mortgages on, substantially all of our tangible and intangible assets and first priority pledges of all the equity interest owned by us in our existing and future domestic subsidiaries.
At December 31, 2006 the maximum amount available under the revolving credit facility was $40.0 million and no balance is outstanding. This amount is available for the entire term per the loan agreement. At December 31, 2006 the
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2004 Loans consisted of a $236.4 million term loan. The term loan is automatically and permanently reduced at the end of each calendar quarter based on a predetermined schedule. In addition to such predetermined reductions, the maximum amount available under the loan agreement will be permanently reduced by (1) beginning June 11, 2004, a portion of an annual “excess cash flow” amount, as defined in the loan agreement, (2) a portion of net proceeds from the Company’s issuance of equity securities, as defined, (3) a portion of net proceeds from the Company’s disposition of assets, as defined, and (4) by voluntary reductions requested at the option of the Company. The Company’s average interest rate for the term loan was 9.32% and 7.50% for 2006 and 2005, respectively. At December 31, 2006, the interest rate in effect was 8.63% through January 25, 2007 for the term loan. The fair value of the term loan approximates carrying value because of the nature of the variable rate of interest.
On November 5, 2005, the Company entered into an amendment to the 2004 Loans, pursuant to which both the total leverage and the senior leverage covenants were increased by 0.25% to provide additional leverage availability, beginning with the period ended December 31, 2005 and ending with the period ended December 31, 2006.
On November 14, 2006, the Company entered into an Amended and Restated Credit Agreement (the “Agreement”) which amends and restates the Credit Agreement dated as of June 11, 2004 and amended as of November 3, 2005, among Language Line, Inc., the Company and the subsidiary guarantors party thereto.
The Agreement effects a refinancing and replacement of the Tranche B Term Loans currently outstanding under the Original Credit Agreement with a new class of Term Loans designated as “Tranche B-1 Term Loans.” The aggregate principal amount of the modified loan is equal to the aggregate principal amount of original loan under the Original Credit Agreement. The modified loan has terms, rights and obligations materially identical to the original loan except that the Applicable Margin for borrowings under the modified loan is 3.25% in the case of Eurodollar loans and 2.25% in the case of Alternate Base Rate Loans. In addition, the Agreement amended related definitions and contained immaterial modifications to various other provisions of the Original Credit Agreement
On June 11, 2004 LLI issued $165 million of 11 1/8% Senior Subordinated Notes (the “Notes”) for net proceeds of $160.8 million. Interest is payable on June 15 and December 15 of each year. The Notes will mature on June 15, 2012. LLI may redeem some or all of the notes at any time on or after June 15, 2008 at the redemption prices set forth. In addition, before June 15, 2007, LLI may redeem up to 35% of the notes with the net proceeds of one or more equity offerings. The notes are unsecured and are subordinated to all existing and future senior indebtedness. Each of LLI’s domestic subsidiaries guarantee the notes on a senior subordinated basis.
Based on quoted market prices and/or the borrowing rates currently available to the Company for long-term debt with similar terms and maturities, the fair value of the Notes is approximately $171.0 million as of December 31, 2006.
On June 11, 2004 the Company issued approximately $109.0 million of 14 1/8% Senior Discount Notes for net proceeds of approximately $55.0 million. No cash interest will accrue on the senior discount notes prior to June 15, 2009. Thereafter, cash interest on the senior discount notes will accrue at a rate of 14 1/8% per annum and be payable semi-annually in arrears on June 15 and December 15 of each year, beginning on December 15, 2009. The senior discount notes are unsecured senior obligations, rank equally with all of the Company’s future senior indebtedness and rank senior to all subordinated indebtedness. The senior discount notes are subordinated to all of the Company’s subsidiaries’ existing and future obligations and are due June 15, 2013.
Based on quoted market prices and/or the borrowing rates currently available to the Company for long-term debt with similar terms and maturities, the fair value of the $109.0 million of 14 1/8% senior discount notes is approximately $75.9 million as of December 31, 2006.
The indentures governing both the Senior Discount Notes and the Senior Subordinated Notes contain covenants limiting, among other things, the Company’s ability and the ability of its subsidiaries to incur additional indebtedness, make restricted payments, make investments, create certain liens, sell assets, restrict payments by the Company’s subsidiaries, guarantee indebtedness, enter into transactions with affiliates, and merge or consolidate or transfer and sell assets. These
51
covenants are subject to important exceptions and qualifications as contained in the indenture. As of December 31, 2006, the Company was in compliance with all covenants as set forth in the indentures.
As of December 31, 2006, principal payments are due approximately as follows (in thousands):
Year Ending December 31, | Term Loans | Senior Subordinated Notes | Senior Discount Notes | Total | ||||||||
2007 | $ | 17,251 | $ | — | $ | — | $ | 17,251 | ||||
2008 | 12,630 | — | — | 12,630 | ||||||||
2009 | 12,630 | — | — | 12,630 | ||||||||
2010 | 12,630 | — | — | 12,630 | ||||||||
2011 | 181,291 | — | — | 181,291 | ||||||||
Thereafter | — | 165,000 | 108,993 | 273,993 | ||||||||
Total | $ | 236,432 | $ | 165,000 | $ | 108,993 | $ | 510,425 | ||||
5. Income Taxes
The provision (benefit) for income taxes consists of the following (in thousands):
| Predecessor | |||||||||||||||
| Year Ended December 31, 2006 | Year Ended December 31, 2005 | June 12, 2004 to December 31, 2004 | January 1, 2004 to June 11, 2004 | ||||||||||||
Current: | |||||||||||||||
Federal | $ | 6,372 | $ | 4,236 | $ | 3,904 | $ | 3,816 | |||||||
State | 1,365 | 1,202 | 695 | 852 | |||||||||||
Total current | 7,737 | 5,438 | 4,599 | 4,668 | |||||||||||
Deferred: | |||||||||||||||
Federal | (9,258 | ) | (8,006 | ) | (5,269 | ) | 1,123 | ||||||||
State | (1,374 | ) | (5,897 | ) | (944 | ) | 177 | ||||||||
Total deferred | (10,632 | ) | (13,903 | ) | (6,213 | ) | 1,300 | ||||||||
Total | $ | (2,895 | ) | $ | (8,465 | ) | $ | (1,614 | ) | $ | 5,968 | ||||
The amount of income tax recorded differs from the amount using the statutory federal income tax rate (35%) for the following reasons (in thousands):
| Predecessor | ||||||||||||||||
| Year Ended December 31, 2006 | Year Ended December 31, 2005 | June 12, 2004 to December 31, 2004 | January 1, 2004 to June 11, 2004 | |||||||||||||
Federal statutory tax expense (benefit) | $ | (4,341 | ) | $ | (6,328 | ) | $ | (1,783 | ) | $ | 5,317 | |||||
State tax expense (benefit) | 29 | (2,985 | ) | (162 | ) | 669 | ||||||||||
Nondeductible expense | 1,186 | 1,021 | 446 | 9 | ||||||||||||
Other | 231 | (173 | ) | (115 | ) | (27 | ) | |||||||||
Total | $ | (2,895 | ) | $ | (8,465 | ) | $ | (1,614 | ) | $ | 5,968 | |||||
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The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and liabilities at December 31 are as follows (in thousands):
| 2006 | December 31, | 2005 | December 31, | |||||||||||||||||||
| Current | Non Current | 2006 | Current | Non Current | 2005 | |||||||||||||||||
Deferred tax assets (liabilities): | ||||||||||||||||||||||
Allowance for uncollectible accounts receivable | $ | 601 | $ | — | $ | 601 | $ | 295 | $ | — | $ | 295 | ||||||||||
State income taxes | 348 | 6,805 | 7,153 | 231 | 7,286 | 7,517 | ||||||||||||||||
Depreciation and amortization | — | (63 | ) | (63 | ) | — | (270 | ) | (270 | ) | ||||||||||||
Acquired intangibles | — | (162,687 | ) | (162,687 | ) | — | (170,366 | ) | (170,366 | ) | ||||||||||||
Accretion of interest on HYDO | — | 6,542 | 6,542 | — | 3,707 | 3,707 | ||||||||||||||||
Other | 64 | — | 64 | 95 | — | 95 | ||||||||||||||||
Net deferred tax liability | $ | 1,013 | $ | (149,403 | ) | $ | (148,390 | ) | $ | 621 | $ | (159,643 | ) | $ | (159,022 | ) | ||||||
Undistributed earnings of the Company’s foreign subsidiaries of approximately $2.4 million at December 31, 2006 and $1.7 million at December 31, 2005, are considered to be indefinitely reinvested and, accordingly, no provision for federal and state income taxes has been provided thereon. Upon distribution of those earnings in the form of dividends or otherwise, the Company would be subject to both U.S. income taxes (subject to an adjustment for foreign tax credits) and withholding taxes payable to various foreign countries.
The Company is subject to ongoing audits from various taxing authorities in the jurisdictions in which it does business and believes it has adequately provided for income tax issues not yet resolved. As of December 31, 2006, approximately $3.1 million had been accrued to provide for such matters. Based on a consideration of all relevant facts and circumstances, the Company does not believe the ultimate resolution of tax issues for all open tax periods will have a materially adverse effect upon its future results of operations or financial condition.
The operations of Language Line Holdings, Inc and subsidiaries are included in the consolidated federal and state income tax returns of its parent, Language Line Holdings, II Inc. Language Line Holdings Inc. and subsidiaries manage the respective tax payments and refunds for Language Line Holdings, II Inc. Income taxes payable at December 31, 2006 and 2005 includes $807,000 and $248,000, respectively, representing amounts due to Language Line Holdings, II Inc. for tax benefits reflected on the consolidated tax returns resulting from operating losses generated by Language Line Holdings, II Inc.
6. Retirement Plans
The Predecessor had and the Company has a 401(k) retirement plan under which employees may elect to make tax deferred contributions, to a maximum established annually by the IRS. For employees meeting a six-month service
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requirement, the Company matches 66.7% of the employees’ contributions up to a maximum of 6% of the employees’ compensation. Contributions vest after three years of service. Predecessor contributions were approximately $193,000 and $238,000 for the period from January 1, 2004 to June 11, 2004 and for the period from June 12, 2004 to December 31, 2004, respectively. Company contributions were approximately $433,000 and $445,000 for the years ended December 31, 2005 and December 31, 2006, respectively.
7. Stock-Based Compensation
Under the Company’s Holdings Class C restricted stock unit plan, officers, employees and outside directors have received or may receive grants of Holdings Class C restricted stock units. Effective January 1, 2006, the Company adopted the provisions of Financial Accounting Standards Board Statement of Financial Accounting Standard (“SFAS”) No. 123(R), “Share-Based Payment,” which establishes the accounting for employee stock-based awards. Under the provisions of SFAS No. 123(R), stock-based compensation is measured at the grant date, based on the calculated fair value of the award, and is recognized as an expense over the requisite employee service period (generally the vesting period of the grant). The Company adopted SFAS No. 123(R) using the modified prospective method and, as a result, periods prior to January 1, 2006 have not been restated. The Company recognized stock-based compensation for grants of its Holdings Class C restricted stock units in the Selling, General and Administrative line item of the Condensed Consolidated Statement of Operations, consistent with compensation recorded for all employees who had previously received grants. Additionally, no modifications were made to outstanding Holdings Class C restricted stock units prior to the adoption of SFAS No. 123(R), and no cumulative adjustments were recorded in the Company’s financial statements.
Prior to January 1, 2006, the Company accounted for the plans under the measurement and recognition provisions of Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees (“APB 25”), and related Interpretations as permitted by SFAS No. 123 (“SFAS 123”), Accounting for Stock Based Compensation. Under APB 25, the Company recorded stock-based compensation expense for its Holdings Class C restricted stock units in its Financial Statements. Stock-based compensation expense was included as a pro forma disclosure in the financial statement footnotes.
Under both SFAS 123 and SFAS 123(R), the Company determines the fair value of its Holdings Class C restricted stock units from the probability-weighted expected return method. Under this method, the value of an enterprise’s common stock is estimated from an analysis of the future values for the Company assuming various possible future liquidity events. SFAS 123(R) requires that the Company recognize compensation expense for only the portion of restricted stock units that are expected to vest, rather than recording forfeitures when they occur, as previously permitted. If the actual number of forfeitures differs from those estimated by management, additional adjustments to compensation expense may be required in future periods.
On January 1, 2006, deferred compensation related to awards issued prior to the adoption of SFAS 123(R) was reduced to zero with a corresponding decrease to capital surplus. SFAS 123(R) requires the Company to reflect the tax savings resulting from tax deductions in excess of expense reflected in its Financial Statements as a financing cash flow, which will impact the Company’s future reported cash flows from operating activities.
Stock-based compensation expense related to Holdings Class C restricted stock units, recognized under SFAS 123(R) for the year ended December 31, 2006 was $415,409. As of December 31, 2006, total unrecognized compensation cost, net of estimated forfeitures, was $1.5 million related to its restricted stock units. The unrecognized compensation cost is expected to be recognized over a weighted-average period of 3.3 years.
The Holdings Class C restricted stock units will vest according to a specified schedule and will be expensed to compensation over the vesting period of five years. Vesting will accelerate upon a change of control of Holdings and upon certain types of sales. Vesting will cease if the individual ceases to be employed by Holdings or any of its subsidiaries. If the individual ceases to be employed by Holdings or any of its subsidiaries, Holdings will have the option to purchase all or any portion of the vested and/or the unvested restricted stock units. The aggregate purchase price for all unvested units will be $1.00, and the purchase price for each vested unit will be the fair market value for such unit as of the date of
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individual’s termination. If, however, the Company terminates the individual’s employment for cause, the aggregate purchase price of all vested units will be $1.00. Holdings right to repurchase the individual’s units will terminate upon a “change of control” (as such term is defined in their incentive unit agreement), provided that the individual is employed by Holdings or any of its subsidiaries at the time of the “change of control.”
As of December 31, 2006 there are 16,073,449 outstanding unvested Holdings Class C restricted stock units, which were granted as restricted stock since June 12, 2004. The company terminated all stock option incentive plans on June 11, 2004 and the plans were not replaced. There are no outstanding or exercisable options with respect to any stock option incentive plans with the Company as of December 31, 2006.
The following table reflects activity under the restricted stock unit plan from December 31, 2005 through December 31, 2006 (in thousands, except per share amounts):
| Number of Units (000) | Weighted Average Grant Date Fair Value | Weighted Average Remaining Contractual Term | ||||||
Outstanding, December 31, 2005 | 19,405 | $ | 0.09 | |||||
Granted | 6,225 | $ | 0.10 | |||||
Repurchased | (454 | ) | $ | 0.09 | ||||
Forfeited | (4,077 | ) | $ | 0.09 | ||||
Outstanding, December 31, 2006 | 21,099 | $ | 0.09 | 3.3 | ||||
A summary of the status of the Company’s nonvested shares as of December 31, 2006 and changes during the period is presented below:
Nonvested Units | Number of Units (000) | Weighted Average Grant Date Fair Value | ||||
Outstanding, December 31, 2005 | 17,464 | $ | 0.09 | |||
Granted | 6,225 | $ | 0.10 | |||
Vested | (3,539 | ) | $ | 0.09 | ||
Forfeited | (4,077 | ) | $ | 0.09 | ||
Outstanding, December 31, 2006 | 16,073 | $ | 0.09 | |||
Holdings Class C restricted stock units granted vest over a 5 year cliff vesting schedule. During the year ended December 31, 2006, 3.5 million units vested. Recipients of restricted stock units do not pay any cash consideration for the units, do not have the right to vote, and do not receive dividends with respect to such units. Compensation expense for restricted stock units is recognized on a straight-line basis over the vesting period, using the restricted stock unit’s fair value on the grant date.
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8. Lease Commitments
The Company leases its operating facilities in the following locations:
Location | Expiration | Option to Extend | ||
Monterey, California | December 2010 | None | ||
Elk Grove, Illinois | November 2011 | None | ||
Dominican Republic | October 2009 | None | ||
Panama (2 leases) | November 2011 and April 2008 | Upon mutual agreement/One period of two years | ||
Costa Rica (2 leases) | April 2007 and 2008 | One period of three years/None |
Future minimum annual lease payments at December 31, 2006 are as follows (in thousands):
Year Ending December 31 | Operating Leases | ||
2007 | $ | 4,050 | |
2008 | 2,660 | ||
2009 | 1,023 | ||
2010 | 831 | ||
2011 | 145 | ||
Total | $ | 8,709 | |
9. Related Party Transactions
The Predecessor paid the principal shareholder of the Company management fees totaling $179,000 for the period from January 1, 2004 to June 11, 2004.
In 2001, the Predecessor loaned $995,000 to an officer in exchange for a note receivable (“Note A”). Note A was collateralized by the officer’s primary residence. In 2002, the Predecessor loaned $100,000 to another officer in exchange for a note receivable (“Note B”). Note B is collateralized by Language Line Holdings, LLC common stock. In connection with the Merger, which occurred on June 11, 2004, both of these loans were modified to extend their maturities. These modifications were made when LLI was a private company not subject to the Sarbanes-Oxley Act of 2002 (the “Act”). In September, 2004, LLI became subject to the Act and as a result the loans may not have been compliant with the Act. To address this matter, on April 13, 2005, $1,095,000 was distributed from LLI in the form of a dividend to its parent, LLHI. LLHI then distributed in the form of a dividend that same amount to its parent, Language Line Holdings III, Inc. (the “Parent”). Parent then made new loans to the executives in the same amount as the loans held by LLI. The loans held by LLI were simultaneously repaid in full by the officers. Each of the dividends and loans mentioned above that occurred on
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April 13, 2005 were effected in non-cash transactions. This action required a waiver from the lenders party to LLI’s credit agreement, which was obtained on April 13, 2005. On May 18, 2005, a capital contribution in the amount of $995,000 was made by the Parent to LLHI when the one officer liable for Note A repaid his loan to the Parent.
The Company paid Language Line Holdings, LLC, the Company’s ultimate parent, a consulting fee of $157,000 for the year ended December 31, 2005.
On January 19, 2006 the Company’s ultimate parent, Language Line Holdings, LLC, completed its acquisition of the unaffiliated U.K. based company Language Line, Limited (“Language Line UK”). Language Line UK’s business operations are independent of the Company and are not included in the accompanying consolidated financial statements. The Company incurred $257,000 of acquisition related costs in 2005 which were reported as a loan to Language Line UK on the Company’s balance sheet as of December 31, 2005. Subsequently the Company received a full amount of settlement on January 20, 2006 when the acquisition was completed. The company has a contract to provide administrative and sales support services to Language Line UK for a fixed monthly fee. The Company recognized revenue of approximately $480,000 for the year ended December 31, 2006 for administrative and sales support services it rendered to Language Line UK.
The operations of Language Line Holdings, Inc and subsidiaries are included in the consolidated federal and state income tax returns of its parent, Language Line Holdings, II Inc. Language Line Holdings Inc. and subsidiaries manage the respective tax payments and refunds for Language Line Holdings, II Inc. Income taxes payable at December 31, 2006 and 2005 includes $807,000 and $248,000, respectively, representing amounts due to Language Line Holdings, II Inc. for tax benefits reflected on the consolidated tax returns resulting from operating losses generated by Language Line Holdings, II Inc.
10. Contingencies
The Predecessor was and the Company is party to certain legal actions arising in the ordinary course of business. Although the ultimate outcome is not presently determinable, management believes that the resolution of such matters will not have a material adverse effect on the Company’s financial position or results of operations.
11. Guarantor and Non-Guarantor Subsidiaries
The Company’s outstanding public debt (the “Senior Subordinated Notes”) is jointly and severally, fully and unconditionally guaranteed by the Company and certain of its subsidiaries (the “Guarantor Subsidiaries”). The Company or Parent Company has no independent assets or operations. The subsidiaries are 100% owned by the Company. At December 31, 2006, a total of approximately $161.7 million of Senior Subordinated Notes were outstanding. The Guarantor Subsidiaries and non-guarantor subsidiaries are direct or indirect wholly-owned subsidiaries of the Company. Separate financial statements of the Company and each of the Guarantor Subsidiaries are not presented because the guarantees are full and unconditional and the Guarantor Subsidiaries are jointly and severally liable.
The non-guaranteeing subsidiaries represent less than 3% on an individual and aggregate basis of consolidated assets, pre-tax earnings, cash flow and equity. Therefore, the non-guarantor subsidiaries’ information is not separately presented.
There are no current restrictions on the ability of the Guarantor Subsidiaries to make payments under the guarantees referred to above. The obligations of each guarantor under its guarantee are limited to the maximum amount permitted under Bankruptcy Law, the Uniform Fraudulent Conveyance Act, the Uniform Fraudulent Transfer Act, or any similar Federal or state law (e.g. laws requiring adequate capital to pay dividends) respecting fraudulent conveyance or fraudulent transfer.
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12. Quarterly Information (Unaudited)
The following tables present certain unaudited consolidated quarterly financial information for each of the eight quarters, in the years ended December 31, 2006 and 2005. This quarterly information has been prepared on the same basis as the Consolidated Financial Statements and includes all adjustments necessary to present fairly the information for the periods presented. The results of operations for any quarter are not necessarily indicative of results for the full year or for any future period. The Company operates as a single segment.
Quarterly Financial Data
(unaudited, in thousands)
| Quarter Ended | ||||||||||||||||
2006 | March 31 | June 30 | September 30 | December 31 | ||||||||||||
Revenues | $ | 40,046 | $ | 40,116 | $ | 41,039 | $ | 42,093 | ||||||||
Income (loss) before taxes | $ | (4,075 | ) | $ | (4,317 | ) | $ | (1,515 | ) | $ | (2,499 | ) | ||||
Income tax (benefit) expense | $ | (1,297 | ) | $ | (1,382 | ) | $ | (291 | ) | $ | 75 | |||||
Net income (loss) | $ | (2,778 | ) | $ | (2,935 | ) | $ | (1,224 | ) | $ | (2,574 | ) | ||||
| Quarter Ended | ||||||||||||||||
2005 | March 31 | June 30 | September 30 | December 31 | ||||||||||||
Revenues | $ | 35,922 | $ | 35,502 | $ | 36,362 | $ | 37,092 | ||||||||
Income (loss) before taxes | $ | (4,734 | ) | $ | (5,165 | ) | $ | (3,888 | ) | $ | (4,294 | ) | ||||
Income tax benefit | $ | (1,654 | ) | $ | (1,844 | ) | $ | (1,317 | ) | $ | (3,650 | ) | ||||
Net income (loss) | $ | (3,080 | ) | $ | (3,321 | ) | $ | (2,571 | ) | $ | (644 | ) | ||||
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LANGUAGE LINE HOLDINGS, INC. AND SUBSIDIARIES
FINANCIAL STATEMENT SCHEDULE
The Financial Statement Schedule II - VALUATION AND QUALIFYING ACCOUNTS
Allowance for Doubtful Accounts | Balance at Beginning of Period | Charged/ Credited to Net Income | Deductions – Write- offs, Net of Recovery | Balance at End of Period | |||||||||
Year ended December 31, 2006 | $ | 738 | $ | 1,254 | ($ | 489 | ) | $ | 1,503 | ||||
Year ended December 31, 2005 | 474 | 435 | (171 | ) | 738 | ||||||||
June 12, 2004 to December 31, 2004 | 637 | 123 | (286 | ) | 474 | ||||||||
January 1, 2004 to June 11, 2004 | 714 | 38 | (115 | ) | 637 | ||||||||
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| Dated: March 16, 2007 | LANGUAGE LINE HOLDINGS, INC. | |||||
| By: | /s/ JEFFREY C. GRACE | |||||
Jeffrey C. Grace CHIEF FINANCIAL OFFICER, VICE PRESIDENT, SECRETARY AND DIRECTOR | ||||||
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on March 16, 2007.
| SIGNATURE | CAPACITY | |||
| /s/ DENNIS G. DRACUP | President, Chief Executive Officer and Director (Principal Executive Officer) | |||
| Dennis G. Dracup | ||||
| /s/ JEFFREY C. GRACE | Chief Financial Officer, Vice President, Secretary and Director (Principal Financial and Accounting Officer) | |||
| Jeffrey C. Grace | ||||
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