UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
(Mark One)
| x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. |
For the quarterly period ended September 30, 2007.
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, CA 93940
(877) 886-3885
(Address, zip code, and telephone number, including
area code, of registrant’s principal executive office.)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 and 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter periods that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes x No ¨
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 ¨ Non-accelerated filer x
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.): Yes ¨ No x
Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date.
Language Line Holdings, LLC owns 100% of the registrant’s common stock.
FORWARD LOOKING STATEMENTS
Statements in this document that are not historical facts are hereby identified as “forward looking statements” for the purposes of the safe harbor provided by Section 21E of the Securities Exchange Act of 1934 (the “Exchange Act”) and Section 27A of the Securities Act of 1933 (the “Securities Act”). Language Line Holdings, Inc. (“LLHI,” “we,” “us,” or the “Company”) cautions readers that such “forward looking statements”, including without limitation, those relating to the Company’s future business prospects, revenue, working capital, liquidity, capital needs, interest costs and income, wherever they occur in this document or in other statements attributable to the Company, are necessarily estimates reflecting the judgment of the Company’s senior management and involve a number of risks and uncertainties that could cause actual results to differ materially from those suggested by the “forward looking statements”. Such “forward looking statements” should, therefore, be considered in light of the factors set forth in “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations”.
The “forward looking statements” contained in this report are made under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations”. Moreover, the Company, through its senior management, may from time to time make “forward looking statements” about matters described herein or other matters concerning the Company.
The Company disclaims any intent or obligation to update “forward looking statements” to reflect changed assumptions, the occurrence of unanticipated events or changes to future operating results over time.
LANGUAGE LINE HOLDINGS, INC. AND SUBSIDIARIES
(An Indirect Wholly-Owned Subsidiary of Language Line Holdings, LLC)
TABLE OF CONTENTS
PART 1. FINANCIAL INFORMATION
| Item 1. | Financial Statements |
LANGUAGE LINE HOLDINGS, INC. AND SUBSIDIARIES
(An Indirect Wholly-Owned Subsidiary of Language Line Holdings, LLC)
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share and par value amounts)
| | | | | | | | |
| | | September 30,
2007 | | | December 31,
2006 | |
Assets | | | | | | | | |
Current assets: | | | | | | | | |
Cash and cash equivalents | | $ | 13,082 | | | $ | 20,236 | |
Accounts receivable, net | | | 27,961 | | | | 24,321 | |
Prepaid expenses and other current assets | | | 1,669 | | | | 1,461 | |
Deferred taxes on income | | | 1,324 | | | | 1,013 | |
| | | | | | | | |
Total current assets | | | 44,036 | | | | 47,031 | |
Property and equipment, net | | | 5,762 | | | | 5,385 | |
Goodwill | | | 408,793 | | | | 408,793 | |
Intangible assets, net | | | 346,973 | | | | 369,139 | |
Deferred financing costs, net | | | 11,238 | | | | 13,253 | |
Other assets | | | 241 | | | | 365 | |
| | | | | | | | |
Total assets | | $ | 817,043 | | | $ | 843,966 | |
| | | | | | | | |
Liabilities and Stockholders’ Equity | | | | | | | | |
Current liabilities: | | | | | | | | |
Accounts payable | | $ | 816 | | | $ | 515 | |
Accrued interest | | | 5,506 | | | | 3,485 | |
Accrued compensation and interpreter costs | | | 5,668 | | | | 4,850 | |
Other accrued liabilities | | | 2,853 | | | | 2,325 | |
Income taxes payable | | | 2,408 | | | | 3,008 | |
Current portion of long-term debt | | | 12,630 | | | | 17,251 | |
| | | | | | | | |
Total current liabilities | | | 29,881 | | | | 31,434 | |
Other liabilities | | | 3,392 | | | | — | |
Long-term debt | | | 209,708 | | | | 219,181 | |
Senior subordinated notes | | | 162,066 | | | | 161,725 | |
Senior discount notes | | | 86,374 | | | | 77,940 | |
Deferred taxes on income | | | 142,092 | | | | 149,403 | |
| | | | | | | | |
Total liabilities | | | 633,513 | | | | 639,683 | |
| | | | | | | | |
Stockholders’ equity: | | | | | | | | |
Common stock, $.01 par value per share and 1,000 shares authorized, issued and outstanding | | | — | | | | — | |
Additional paid-in capital | | | 207,436 | | | | 227,137 | |
Accumulated deficit | | | (23,906 | ) | | | (22,854 | ) |
| | | | | | | | |
Total stockholders’ equity | | | 183,530 | | | | 204,283 | |
| | | | | | | | |
Total liabilities and stockholders’ equity | | $ | 817,043 | | | $ | 843,966 | |
| | | | | | | | |
See notes to condensed consolidated financial statements.
1
LANGUAGE LINE HOLDINGS, INC. AND SUBSIDIARIES
(An Indirect Wholly-Owned Subsidiary of Language Line Holdings, LLC)
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands)
(Unaudited)
| | | | | | | | | | | | | | | |
| | | Three months
ended
September 30,
2007 | | Three months
ended
September 30,
2006 | | | Nine months
ended
September 30,
2007 | | | Nine months
ended
September 30,
2006 | |
Revenues | | $ | 46,177 | | $ | 41,039 | | | $ | 136,916 | | | $ | 121,201 | |
Cost of services | | | 16,398 | | | 14,339 | | | | 48,279 | | | | 42,625 | |
Other expenses: | | | | | | | | | | | | | | | |
Selling, general and administrative | | | 8,338 | | | 7,060 | | | | 24,518 | | | | 21,314 | |
Interest | | | 13,354 | | | 13,953 | | | | 39,748 | | | | 40,619 | |
Depreciation and amortization | | | 7,310 | | | 8,249 | | | | 24,001 | | | | 27,826 | |
| | | | | | | | | | | | | | | |
Total other expenses | | | 29,002 | | | 29,262 | | | | 88,267 | | | | 89,759 | |
| | | | | | | | | | | | | | | |
Other income: | | | | | | | | | | | | | | | |
Interest | | | 236 | | | 252 | | | | 679 | | | | 480 | |
Escrow settlement | | | — | | | 795 | | | | — | | | | 795 | |
| | | | | | | | | | | | | | | |
Total other income | | | 236 | | | 1,047 | | | | 679 | | | | 1,275 | |
| | | | | | | | | | | | | | | |
Income (loss) before taxes on income | | | 1,013 | | | (1,515 | ) | | | 1,049 | | | | (9,908 | ) |
Taxes (benefit) on income (loss) | | | 603 | | | (291 | ) | | | 1,297 | | | | (2,971 | ) |
| | | | | | | | | | | | | | | |
Net income (loss) | | $ | 410 | | $ | (1,224 | ) | | $ | (248 | ) | | $ | (6,937 | ) |
| | | | | | | | | | | | | | | |
See notes to condensed consolidated financial statements.
2
LANGUAGE LINE HOLDINGS, INC. AND SUBSIDIARIES
(An Indirect Wholly-Owned Subsidiary of Language Line Holdings, LLC)
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
| | | | | | | | |
| | | Nine months
ended
September 30,
2007 | | | Nine months
ended
September 30,
2006 | |
Cash flows from operating activities: | | | | | | | | |
Net income (loss) | | $ | (248 | ) | | $ | (6,937 | ) |
Adjustments to reconcile net loss to net cash provided by operating activities: | | | | | | | | |
Depreciation and amortization | | | 24,001 | | | | 27,826 | |
Amortization of deferred financing costs | | | 2,015 | | | | 1,635 | |
Deferred taxes on income | | | (7,016 | ) | | | (8,166 | ) |
Stock based compensation expense | | | 310 | | | | 313 | |
Accretion of discount on long-term debt | | | 8,775 | | | | 7,662 | |
Loss on fixed asset disposals | | | 3 | | | | — | |
Effect of changes in operating assets and liabilities: | | | | | | | | |
Accounts receivable | | | (3,640 | ) | | | (1,574 | ) |
Prepaid expenses and other current assets | | | (208 | ) | | | 449 | |
Other assets | | | 124 | | | | (223 | ) |
Accounts payable | | | 301 | | | | 1,742 | |
Income taxes payable | | | (2,010 | ) | | | 303 | |
Accrued interest and other liabilities | | | 6,759 | | | | 6,187 | |
| | | | | | | | |
Net cash provided by operating activities | | | 29,166 | | | | 29,217 | |
| | | | | | | | |
Cash flows from investing activities: | | | | | | | | |
Purchase of property and equipment | | | (2,039 | ) | | | (2,478 | ) |
Acquisition of intangible asset | | | (175 | ) | | | — | |
| | | | | | | | |
Net cash used in investing activities | | | (2,214 | ) | | | (2,478 | ) |
| | | | | | | | |
Cash flows from financing activities: | | | | | | | | |
Long-term debt repayments | | | (14,094 | ) | | | (15,098 | ) |
Revolving line of credit borrowings | | | 11,000 | | | | — | |
Revolving line of credit repayments | | | (11,000 | ) | | | — | |
Repurchase of restricted stock units | | | (12 | ) | | | (15 | ) |
Dividend paid to parent company | | | (20,000 | ) | | | — | |
| | | | | | | | |
Net cash used in financing activities | | | (34,106 | ) | | | (15,113 | ) |
| | | | | | | | |
Net (decrease) increase in cash and cash equivalents | | | (7,154 | ) | | | 11,626 | |
Cash and cash equivalents - beginning of period | | | 20,236 | | | | 13,991 | |
| | | | | | | | |
Cash and cash equivalents - end of period | | $ | 13,082 | | | $ | 25,617 | |
| | | | | | | | |
Supplemental cash flow disclosures: | | | | | | | | |
Cash paid for interest | | $ | 26,835 | | | $ | 26,143 | |
| | | | | | | | |
Cash paid for income taxes | | $ | 7,201 | | | $ | 4,893 | |
| | | | | | | | |
See notes to condensed consolidated financial statements.
3
LANGUAGE LINE HOLDINGS, INC. AND SUBSIDIARIES
(An Indirect Wholly-Owned Subsidiary of Language Line Holdings, LLC)
Notes to Condensed Consolidated Financial Statements
(Unaudited)
1. Organization and Significant Accounting Policies
The accompanying unaudited condensed consolidated financial information has been prepared in accordance with the Securities and Exchange Commission (“SEC”) regulations for interim financial reporting. In the opinion of management, the condensed consolidated financial statements include all adjustments, consisting only of normal recurring adjustments, that are considered necessary for a fair statement of the Company’s financial position, results of operations and cash flows for the interim periods. Operating results for the nine months ended September 30, 2007 and September 30, 2006 are not necessarily indicative of results that may be expected for the entire year. This financial information should be read in conjunction with the audited consolidated financial statements and notes thereto for the year ended December 31, 2006 of Language Line Holdings, Inc., which are included in the Form 10-K filed with the SEC on March 16, 2007.
In accordance with the rules and regulations of the SEC, unaudited condensed consolidated financial statements may omit or condense certain information and disclosures normally required for a complete set of financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). Accordingly, certain information and disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. We believe that the notes to the condensed consolidated financial statements contain disclosures adequate to make the information presented not misleading.
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 condensed consolidated financial statements include the accounts of LLHI, LLI, LLC and LLC’s wholly-owned subsidiaries as of September 30, 2007 and December 31, 2006, and for the three months and nine months ended September 30, 2007 and 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.
Accrued compensation and interpreter costs—Accrued compensation and interpreter costs are current compensation obligations due to internal employees and agency interpreters. This includes components of known costs due to agency interpreters as well as accrued estimates for internal employees and agency interpreters.
Reclassifications—Interest income and expense have been reclassified to be presented on a gross basis for the periods ended September 30, 2006 to conform to the September 30, 2007 presentation. Portions of selling, general and administrative expenses have been reclassified to cost of services for the periods ended September 30, 2006 to conform to the September 30, 2007 presentation.
4
On the Balance Sheet the Company combined accrued payroll and related benefits with accrued cost of interpreters into accrued compensation and interpreter costs. Portions of accounts payable have been reclassified to accrued compensation under current liabilities for the periods ended December 31, 2006 to conform to the September 30, 2007 presentation.
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 carry forwards 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.
Comprehensive Income—SFAS No. 130,Reporting Comprehensive Income, requires that the Company report comprehensive income, which includes net income (loss) as well as other changes in assets and liabilities recorded directly to equity, in its financial statements. There were no components of comprehensive income other than net income (loss) for all periods presented.
Recently Adopted Accounting Changes—The Company adopted FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes”—an interpretation of FASB Statement No. 109 (“FIN 48”), effective from January 1, 2007. FIN 48 changed the test for recognition of uncertain tax positions to a “more-likely-than-not recognition threshold” which is defined as “greater than 50 percent”. Once the threshold is crossed, the enterprise then recognizes its best estimate of the amount that will ultimately be sustained upon review by the relevant tax authorities.
As a consequence of adopting FIN 48, the Company recorded a $4.2 million increase in other liabilities, a $2.8 million decrease in income tax payable, a $0.6 million decrease in deferred tax liabilities, and a cumulative adjustment of $0.8 million to opening accumulated deficit at January 1, 2007.
Total unrecognized tax benefits as of January 1, 2007 totaled $4.5 million and, if recognized, would impact the Company’s effective tax rate. We expect that within the next twelve months, we will make total settlement payments on tax positions of at least $0.3 million. During the three and nine months ended September 30, 2007, the Company recorded a decrease in its total unrecognized tax benefits of $0.7 million and $1.1 million, respectively, primarily due to the Company making payments or agreeing with taxing authorities on certain tax positions.
The Company recognizes interest and penalties relating to unrecognized tax benefits as part of its income tax expense. Total accrued interest and penalties as of January 1, 2007 were $0.7 million and $0.2 million, respectively.
The Company files income tax returns in U.S. federal jurisdiction along with various state and foreign jurisdictions, and is subject to ongoing audits from various taxing authorities in the jurisdictions in which it does business. With certain exceptions, the Company is no longer subject to examinations from taxing authorities for years prior to 2003. The Franchise Tax Board (“FTB”) of the State of California is currently examining the Company’s California income tax returns for 2003 and 2004. The Company has agreed with certain FTB findings and will make income tax settlement payments on tax positions of at least $0.3 million within the next 12 months. The Company is currently disputing a FTB finding with an estimated income tax effect of $0.2 million.
The following table illustrates the incremental effect of applying FIN 48 on individual line items on the condensed consolidated balance sheet as of January 1, 2007.
5
| | | | | | | | | | | | |
| | | Before
application
of FIN 48 | | | Effect of
FIN 48
application | | | After
Application
of FIN 48 | |
| | | (millions) | |
Deferred taxes | | $ | 1,013 | | | $ | (3 | ) | | $ | 1,010 | |
Total assets | | | 843,966 | | | | (3 | ) | | | 843,963 | |
Income taxes payable | | | 3,008 | | | | (2,772 | ) | | | 236 | |
Other liabilities | | | — | | | | 4,181 | | | | 4,181 | |
Deferred taxes | | | 149,403 | | | | (609 | ) | | | 148,794 | |
Total liabilities | | | 639,683 | | | | 800 | | | | 640,483 | |
Accumulated deficit | | | (22,854 | ) | | | (803 | ) | | | (23,657 | ) |
Total stockholders’ equity | | | 204,283 | | | | (803 | ) | | | 203,480 | |
Total liabilities and stockholders’ equity | | $ | 843,966 | | | $ | (3 | ) | | $ | 843,963 | |
In June 2006, the Financial Accounting Standards Board (“FASB”) ratified the Emerging Issues Task Force No. 06-3 (“EITF 06-3”), “How Taxes Collected from Customers and Remitted to Governmental Authorities Should be Presented in the Income Statement.” The pronouncement addresses disclosure requirements for taxes assessed by a governmental authority that is both imposed on and concurrent with a specific revenue-producing transaction between a seller and a customer, and may include, but is not limited to, sales, use, value added, certain excise taxes and some industry-specific taxes. A consensus was reached that entities may adopt a policy of presenting these taxes in the income statement on either a gross or net basis. If such taxes are significant, EITF 06-3 requires disclosure of the accounting method in the accounting policy section of the notes to the financial statements, and if not presented at net, then disclosure is required for the amount of such taxes that are recognized on a gross basis. We adopted EITF 06-3 on our effective date of January 1, 2007. We present revenues net of sales and value-added taxes in our consolidated financial position and results of operations. We believe the impact of adopting EITF 06-3 is immaterial.
Recent Accounting Pronouncements Non Adopted
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.
2. Guarantor Subsidiaries
The Company’s outstanding public debt (the “Senior Subordinated Notes”) is jointly and severally, fully and unconditionally guaranteed by the Company and 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 September 30, 2007, a total of approximately $162.1 million of Senior Subordinated Notes were outstanding. The Guarantor Subsidiaries
6
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.
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.
3. Contingencies
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, results of operations, or cash flows.
4. Stock-Based Compensation
On August 31, 2007 the company granted 1.75 million Class C restricted stock units. 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. The weighted average grant date fair value of this award is $0.14. The Company recognizes stock-based compensation expense 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.
The Holding Class C restricted stock units will vest according to a specified schedule and will be recorded as compensation expense 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 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” (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.”
| Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
The following Management’s Discussion and Analysis of our Financial Condition and Results of Operations should be read in conjunction with the condensed consolidated financial statements and notes thereto included as part of this Form 10-Q. This report contains forward-looking statements that are based upon current expectations. We sometimes identify forward-looking statements with such words as “may”, “will”, “expect”, “anticipate”, “estimate”, “seek”, “intend”, “believe” or similar words concerning future events. The forward-looking statements contained herein, include, without limitation, statements concerning future revenue sources and concentration, gross profit margins, selling and marketing expenses, research and development expenses, general and administrative expenses, capital resources, additional financings or borrowings and additional losses and are subject to risks and uncertainties including, but not limited to, those discussed below and elsewhere in this Form 10-Q that could cause actual results to differ materially from the results contemplated by these forward-looking statements. We also urge you to carefully review the risk factors set forth in other documents we file from time to time with the SEC.
Introduction
We are the leading 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
7
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, providing over 90 million billed minutes of 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 cost of services, selling, general and administrative expenses, depreciation and amortization and interest expense. Cost of services primarily include the cost of our interpreters and telecommunications related costs.
Results of Operations
The following table sets forth the percentages of revenue that certain items of operating data constitute for the periods indicated:
| | | | | | | | | | | | |
| | | Three Months
Ended
September 30, 2007 | | | Three Months
Ended
September 30, 2006 | | | Nine Months
Ended
September 30, 2007 | | | Nine Months
Ended
September 30, 2006 | |
Statement of Operations data: | | | | | | | | | | | | |
Revenues | | 100.0 | % | | 100.0 | % | | 100.0 | % | | 100.0 | % |
Cost of services | | 35.5 | % | | 34.9 | % | | 35.3 | % | | 35.2 | % |
Other expenses: | | | | | | | | | | | | |
Selling, general and administrative | | 17.9 | % | | 17.2 | % | | 17.8 | % | | 17.6 | % |
Interest | | 28.9 | % | | 34.0 | % | | 29.0 | % | | 33.5 | % |
Depreciation and amortization | | 15.8 | % | | 20.1 | % | | 17.5 | % | | 23.0 | % |
| | | | | | | | | | | | |
Total other expenses | | 62.6 | % | | 71.3 | % | | 64.3 | % | | 74.1 | % |
| | | | | | | | | | | | |
Other income: | | | | | | | | | | | | |
Interest | | 0.5 | % | | 0.6 | % | | 0.5 | % | | 0.4 | % |
Special Payment Received | | 0.0 | % | | 1.9 | % | | 0.0 | % | | 0.7 | % |
| | | | | | | | | | | | |
Total other income | | 0.5 | % | | 2.5 | % | | 0.5 | % | | 1.1 | % |
| | | | | | | | | | | | |
Income (loss) before taxes on income | | 2.4 | % | | (3.7 | %) | | 0.9 | % | | (8.2 | %) |
Tax (benefit) on income (loss) | | 1.3 | % | | (0.7 | %) | | 0.9 | % | | (2.5 | %) |
| | | | | | | | | | | | |
Net income (loss) | | 1.1 | % | | (3.0 | %) | | 0.0 | % | | (5.7 | %) |
| | | | | | | | | | | | |
Three Months Ended September 30, 2007 Compared to the Three Months Ended September 30, 2006
Revenues for the three months ended September 30, 2007 were $46.2 million as compared to $41.0 million for the three months ended September 30, 2006, an increase of $5.2 million or 12.7%. The majority of the increase in revenue is driven by a 18.2% increase in OPI billed minutes, offset by a 4.1% decline in the average rate per billed minute.
Cost of services consists primarily of costs associated with interpretation services and customer support. Significant cost components include compensation of interpreters and telecommunication charges. For the three months ended September 30, 2007, cost of services were $16.4 million as compared to $14.3 million for the three months ended September 30, 2006, an increase of $2.1 million or 14.7%. This increase was primarily due to increased interpretation minutes offset by a lower cost per minute.
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Selling, general and administrative expenses for the three months ended September 30, 2007 were $8.2 million as compared to $7.1 million for the three months ended September 30, 2006, an increase of $1.1 million or 15.5%. This increase was primarily due to the results of an increase in marketing and sales initiatives as well as recruiting initiatives.
Interest expense for the three months ended September 30, 2007 was $13.4 million as compared to $14.0 million for the three months ended September 30, 2006, a decrease of $0.6 million or 4.3%. This was primarily due to a decrease in the interest rate in 2007 versus 2006 on our term loan combined with a reduction in the principal balance of our term loan.
Depreciation and amortization was $7.3 million for the three months ended September 30, 2007 compared to $8.3 million for the three months ended September 30, 2006, a decrease of $0.9 million or 11.0%. The decrease was primarily due to one intangible asset being fully amortized in 2006.
Interest income for the three months ended September 30, 2007 was $0.2 million as compared to $0.3 million for the three months ended September 30, 2006, a decrease of $0.1 million or 33.3%. For the three months ended September 30, 2007, the Company had a lower cash balance which earned higher interest, and for the three months ended September 30, 2006, the Company had a higher cash balance which earned lower interest, resulting in a decrease between the periods.
The tax expense on income for the three months ended September 30, 2007 was $0.6 million as compared to $0.3 million of tax benefit on loss for the three months ended September 30, 2006, a change of $0.9 million. This change in tax expense is primarily due to a $2.6 million change in pretax results of operations (income before income taxes of $1.0 million for the three months ended September 30, 2007 compared to a loss before income taxes of $1.5 million for the three months ended September 30, 2006). The effective tax rate for the three months ended September 30, 2007 was 60% as compared to 19% for the three months ended September 30, 2006. The Company’s effective tax rate is significantly impacted by its permanent differences, which are significant in relation to the income (loss) before taxes on income. The effect of such permanent differences is to increase the Company’s effective tax rate on pretax income and decrease its effective tax benefit on pretax losses.
As a result of the factors described above, net income was $0.5 million for the three months ended September 30, 2007 as compared to a net loss of $1.2 million for the three months ended September 30, 2006.
Nine Months Ended September 30, 2007 Compared to the Nine Months Ended September 30, 2006
Revenues for the nine months ended September 30, 2007 were $136.9 million as compared to $121.2 million for the nine months ended September 30, 2006, an increase of $15.7 million or 12.9%. The majority of the increase in revenue is driven by a 19.9% increase in OPI billed minutes offset by a 5.8% decline in the average rate per billed minute.
Cost of services consists primarily of costs associated with interpretation services and customer support. Significant cost components include compensation of interpreters and telecommunication charges. For the nine months ended September 30, 2007, cost of services were $48.3 million as compared to $42.6 million for the nine months ended September 30, 2006, an increase of $5.7 million or 13.4%. This increase was primarily due to increased interpretation minutes offset by a lower cost per minute.
Selling, general and administrative expenses for the nine months ended September 30, 2007 were $24.4 million as compared to $21.3 million for the nine months ended September 30, 2006, an increase of $3.1 million or 14.6%. This increase was primarily due to the results of an increase in marketing and sales initiatives as well as recruiting initiatives.
Interest expense for the nine months ended September 30, 2007 was $39.7 million as compared to $40.6 million for the nine months ended September 30, 2006, a decrease of $0.9 million or 2.2%. This was primarily due to a decrease in the interest rate in 2007 versus 2006 on our term loan combined with a reduction in the principle balance of our term loan.
Depreciation and amortization was $24.0 million for the nine months ended September 30, 2007 compared to $27.8 million for the nine months ended September 30, 2006, a decrease of $3.8 million or 13.7%. The decrease was primarily due to one intangible asset being fully amortized in 2006.
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The tax expense on income for the nine months ended September 30, 2007 was $1.3 million as compared to $3.0 million of tax benefit on loss for the nine months ended September 30, 2006, a change of $4.3 million. This change in tax expense is primarily due an $11.0 million change in pretax results of operations (income before income taxes of $1.1 million for the nine months ended September 30, 2007 compared to a loss before income taxes of $9.9 million for the nine months ended September 30, 2006). The effective tax rate for the nine months ended September 30, 2007 was 124% as compared to 30% for the nine months ended September 30, 2006. The Company’s effective tax rate is significantly impacted by its permanent differences, which are significant in relation to the income (loss) before taxes on income. The effect of such permanent differences is to increase the Company’s effective tax rate on pretax income and decrease its effective tax benefit on pretax losses.
As a result of the factors described above, net loss was $0.2 million for the nine months ended September 30, 2007 as compared to a net loss of $6.9 million for the nine months ended September 30, 2006.
Recent Accounting Pronouncements
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.
Liquidity and Capital Resources
Operating Activities. Net cash provided by operating activities for the nine months ended September 30, 2007 was $29.2 million compared with net cash provided by operating activities during the nine months ended September 30, 2006 of $29.2 million.
Investing Activities. Net cash used in investing activities was $2.2 million for the nine months ended September 30, 2007, compared to $2.5 million for the nine months ended September 30, 2006. This decrease was mainly attributable to a reduction in capital expenditure spending.
Financing Activities. Net cash used in financing activities during the nine months ended September 30, 2007 was $34.1 million, compared to $15.1 million during the nine months ended September 30, 2006. The increase of $19.0 million is the result of the $20.0 million dividend distribution issued on April 25, 2007 to Language Line Holdings II, Inc. an affiliated non-consolidated entity under the ultimate parent, Language Line Holdings, LLC. The distribution was recorded as a reduction to Additional-Paid-In-Capital in the consolidated financial statements of Language Line Holdings, Inc. and Subsidiaries due to our accumulated deficit.
As a result of issuing the dividend, the Company borrowed $11.0 million under our revolving credit facility during the nine months ended September 30, 2007. The $11.0 million borrowed was fully repaid by the Company during the nine months ended September 30, 2007. At September 30, 2007 the maximum amount available under the revolving credit facility was $40.0 million, and no balance is outstanding.
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We expect to continue to generate positive cash flows from operations for the remainder of 2007. We believe cash flow from operations will provide us with sufficient liquidity and capital resources 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 for the next twelve months.
Debt Service. As of September 30, 2007, we had total indebtedness of $470.8 million and $40.0 million of borrowings available under our revolver credit facility, as defined in our loan agreement and subject to customary conditions.
The senior secured credit facilities consist of a six-year $40.0 million revolving credit facility and a seven-year amortizing $240.0 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 secured by first priority interests in, and mortgages on, substantially all of our tangible and intangible assets and first priority pledges of all the equity interests owned by us in our existing and future domestic subsidiaries. The facility contains covenants that require the Company to maintain various financial statement ratios. The Company was compliant with these covenants at September 30, 2007.
Our senior subordinated notes mature in 2012 and are guaranteed by each of our existing domestic subsidiaries on a senior subordinated basis. Interest on the notes will be payable semi-annually in cash.
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.
Contractual and Commercial Commitments Summary
The following tables present our long-term contractual cash obligations as of September 30, 2007 (dollars in thousands):
| | | | | | | | | | | | | | | | | | | | | |
| | | Total | | 2007 | | 2008 | | 2009 | | 2010 | | 2011 | | Thereafter |
Senior secured credit facilities | | $ | 222,339 | | $ | 3,158 | | $ | 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 | | | 216,586 | | | 13,858 | | | 36,412 | | | 43,047 | | | 49,681 | | | 41,317 | | | 32,271 |
Unrecognized tax benefits | | | 311 | | | 311 | | | — | | | — | | | — | | | — | | | — |
Operating leases | | | 5,725 | | | 1,036 | | | 2,684 | | | 1,029 | | | 831 | | | 145 | | | — |
| | | | | | | | | | | | | | | | | | | | | |
Total cash contractual obligations | | $ | 718,954 | | $ | 18,363 | | $ | 51,726 | | $ | 56,706 | | $ | 63,142 | | $ | 222,753 | | $ | 306,264 |
| | | | | | | | | | | | | | | | | | | | | |
Interest payments with respect to the senior secured credit facilities assume a variable rate of 8.42%, which represents the most recent rate applicable to these facilities. 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.
We expect that, within the next twelve months, we will make income tax settlement payments on tax positions of at least $0.3 million. Since settlement of all other tax positions can not be reasonably estimated due to uncertainties in the timing of tax audit outcomes, $3.1 million is not included in the Contractual and Commercial Commitment Summary.
Critical Accounting Policies
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.
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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.
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.
| Item 3. | Quantitative and Qualitative Disclosure 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.
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As of September 30, 2007, we had $274.0 million principal amount of fixed-rate debt and $262.3 million of available floating-rate debt (of which we borrowed $222.3 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 $2.2 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 4T. | 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.
Restatement of Previously Issued Condensed Consolidated Financial Statements
On September 13, 2007, we filed an amendment on Form 10-Q/A to our quarterly report on Form 10-Q for the three months ended March 31, 2007 to restate our unaudited condensed consolidated financial statements for the three months ended March 31, 2007.
Evaluation of our Disclosure 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 and because of the material weakness described below, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were not effective, at the reasonable assurance level, to enable us to record, process, summarize, and report information required to be included in our periodic SEC filings within the required time period or to ensure the information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act is accumulated and communicated to the Company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure.
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Material Weakness in Internal Control over Financial Reporting
A material weakness is a control deficiency, or a combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. Management identified the following material weakness as of September 30,2007 and during the restatement process relating to the Company’s internal control over financial reporting:
| | • | | The Company did not maintain a sufficient complement of personnel with an appropriate level of accounting knowledge, experience and training in the application of generally accepted accounting principles commensurate with the Company’s financial reporting requirements. Specifically, the Company had deficiencies in finance and accounting staff with sufficient depth and skill in the application of U.S. generally accepted accounting principles and the staffing of finance positions with individuals who did not have the appropriate skills, training and experience to meet the objectives that should be expected of these roles. The Company also lacked sufficient resources to properly perform the quarterly financial close processes, including the review of income tax expense, income taxes payable and deferred income tax assets and liabilities. |
The above control deficiency resulted in the need for the restatement of our unaudited condensed consolidated financial statements for the three months ended March, 2007. Additionally, this control deficiency could result in a misstatement in the aforementioned account balances or disclosures that would result in a material misstatement to our annual or interim financial statements that would not be prevented or detected.
Remediation Efforts
Management, with Audit Committee oversight, has begun implementing the following actions to remediate the material weakness and deficiencies in disclosure controls and procedures described above:
| | 1. | Efforts to strengthen accounting and finance department through additional professional staff. We recently hired a new Chief Financial Officer with previous experience as the Chief Financial Officer of SEC registrants. We will continue to seek to strengthen our accounting and finance department with additional staff with the skills and experience needed for a public company of our size and complexity. |
| | 2. | Implementation of enhanced training for our finance and accounting personnel to familiarize them with our accounting policies. |
| | 3. | Increased communication internally and with outside advisors. We are in the process of implementing policies and processes to increase communication by and among senior management, external advisors and other third parties relevant to the disclosure process. |
Changes in Internal Control Over Financial Reporting
As announced on June 15, 2007, the Company hired a finance executive with previous experience as the Chief Financial Officer of SEC Registrants. This executive joined the Company on July 23, 2007 and is the Chief Financial Officer of the Company effective August 15, 2007.
Other than the remedial measure described above, there were no other changes in our internal control over financial reporting that have materially affected, or are likely to materially affect our internal control over financial reporting during the three months ended September 30, 2007.
PART 2. OTHER INFORMATION
Language Line Holdings, Inc. is not currently involved in any material legal proceedings.
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For a more detailed explanation of the factors affecting our business, please refer to the Risk Factors section in our Form 10-K for the fiscal year ended December 31, 2006.
There have been no material changes from Risk Factors previously disclosed in our Form 10-K.
| Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds |
Language Line Holdings, LLC exercised its right to repurchase an aggregate 50,000 vested Class C Common Units at Fair Market Value (the “Vested Units”) in the amount of $7,000 and a total of 125,000 of unvested Class C Common Units for a $1.00 aggregate purchase price.
| Item 3. | Defaults upon Senior Securities |
None.
| Item 4. | Submission of Matters to a Vote of Security Holders |
None.
None.
| Item 6. | Exhibits and Reports on Form 8-K |
| | |
| 31.1 | | Certification by Dennis G. Dracup pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| |
| 31.2 | | Certification by Michael Schmidt pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| |
| 32.1 | | Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 – Chief Executive Officer. |
| |
| 32.2 | | Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 – Chief Financial Officer. |
None.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this Form 10-Q to be signed on its behalf by the undersigned, thereunto duly authorized in the City of Monterey, California on November 9, 2007.
|
| LANGUAGELINE HOLDINGS, INC. |
|
| /s/ Dennis G. Dracup |
| Dennis G. Dracup |
| Chief Executive Officer and Director |
|
| /s/ Michael Schmidt |
| Michael Schmidt |
| Chief Financial Officer and, Secretary |
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