UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
| þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. |
For the quarterly period ended March 31, 2009.
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 x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Item 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ¨ No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer or a small reporting company. See definition of “large accelerated filer, accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
| | | | | | |
| ¨ Large accelerated filer | | ¨ Accelerated filer | | x Non-accelerated filer | | ¨ Smaller reporting company |
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 March 31, 2009, 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.
FORWARD LOOKING STATEMENTS
This Quarterly Report on Form 10-Q 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 factors set forth in “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the risks and uncertainties that could cause Language Line Holdings, Inc.’s (“LLHI,” “we,” “us,” or 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. 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. We assume no obligation to update any forward-looking statements.
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)
(Unaudited)
| | | | | | | |
| | | March 31, 2009 | | December 31, 2008 | |
Assets | | | | | | | |
Current assets: | | | | | | | |
Cash and cash equivalents | | $ | 32,969 | | $ | 15,046 | |
Accounts receivable, net | | | 36,891 | | | 33,394 | |
Prepaid expenses and other current assets | | | 4,725 | | | 5,911 | |
Income taxes receivable | | | — | | | 2,105 | |
Due from Coto Holdings, LLC (Note 4) | | | 2,917 | | | 2,387 | |
Deferred taxes on income | | | 2,635 | | | 2,971 | |
| | | | | | | |
Total current assets | | | 80,137 | | | 61,814 | |
Property and equipment, net | | | 8,280 | | | 8,547 | |
Goodwill | | | 408,793 | | | 408,793 | |
Intangible assets, net | | | 306,534 | | | 313,290 | |
Deferred financing costs, net | | | 7,208 | | | 7,880 | |
Other assets | | | 263 | | | 244 | |
| | | | | | | |
Total assets | | $ | 811,215 | | $ | 800,568 | |
| | | | | | | |
Liabilities and Stockholders’ Equity | | | | | | | |
Current liabilities: | | | | | | | |
Accounts payable | | $ | 1,808 | | $ | 1,866 | |
Accrued interest | | | 5,378 | | | 791 | |
Accrued compensation and interpreter costs | | | 8,889 | | | 7,059 | |
Other accrued liabilities | | | 4,107 | | | 4,265 | |
Income taxes payable | | | 4,596 | | | — | |
Due to Language Line Holdings, II Inc. | | | 1,330 | | | 2,229 | |
Current portion of long-term debt | | | 12,071 | | | 16,339 | |
| | | | | | | |
Total current liabilities | | | 38,179 | | | 32,549 | |
| | | | | | | |
Other liabilities | | | 753 | | | 737 | |
Long-term debt | | | 182,327 | | | 185,336 | |
Senior subordinated notes | | | 162,838 | | | 162,699 | |
Senior discount notes | | | 105,997 | | | 102,402 | |
Deferred taxes on income | | | 126,410 | | | 131,965 | |
| | | | | | | |
Total liabilities | | | 616,504 | | | 615,688 | |
| | | | | | | |
Stockholders’ equity: | | | | | | | |
Common stock, $.01 par value per share and 1,000 shares authorized, issued and outstanding | | | — | | | — | |
Additional paid-in capital | | | 189,996 | | | 189,882 | |
Retained Earnings (Accumulated deficit) | | | 4,715 | | | (5,002 | ) |
| | | | | | | |
Total stockholders’ equity | | | 194,711 | | | 184,880 | |
| | | | | | | |
Total liabilities and stockholders’ equity | | $ | 811,215 | | $ | 800,568 | |
| | | | | | | |
See notes to condensed consolidated financial statements.
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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
March 31, 2009 | | Three months ended
March 31, 2008 |
Revenues | | $ | 60,021 | | $ | 48,897 |
Cost of services | | | 18,690 | | | 16,326 |
Other expenses: | | | | | | |
Selling, general and administrative | | | 11,745 | | | 8,567 |
Interest | | | 11,417 | | | 12,559 |
Depreciation and amortization | | | 7,331 | | | 7,369 |
| | | | | | |
Total other expenses | | | 30,493 | | | 28,495 |
| | | | | | |
Other income: | | | | | | |
Interest | | | — | | | 254 |
Other | | | 103 | | | 335 |
| | | | | | |
Total other income | | | 103 | | | 589 |
| | | | | | |
Income before taxes on income | | | 10,941 | | | 4,665 |
Taxes on income | | | 1,224 | | | 2,364 |
| | | | | | |
Net income | | $ | 9,717 | | $ | 2,301 |
| | | | | | |
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)
| | | | | | | | |
| | | Three months ended
March 31, 2009 | | | Three months ended
March 31, 2008 | |
Cash flows from operating activities: | | | | | | | (Revised) | |
Net income | | $ | 9,717 | | | $ | 2,301 | |
Adjustments to reconcile net income to net cash provided by operating activities: | | | | | | | | |
Depreciation and amortization | | | 7,331 | | | | 7,369 | |
Amortization of deferred financing costs | | | 672 | | | | 671 | |
Deferred taxes on income | | | (5,219 | ) | | | (1,489 | ) |
Stock based compensation expense | | | 114 | | | | 106 | |
Accretion of discount on long-term debt | | | 3,734 | | | | 3,260 | |
Loss on fixed asset disposals | | | | | | | | |
Effect of changes in operating assets and liabilities: | | | | | | | | |
Accounts receivable | | | (3,497 | ) | | | 1,629 | |
Prepaid expenses and other current assets | | | 1,186 | | | | (382 | ) |
Due from Coto Holdings, LLC | | | (530 | ) | | | (844 | ) |
Due to Language Line Holdings, II, Inc. | | | (899 | ) | | | 724 | |
Other assets | | | (19 | ) | | | — | |
Accounts payable | | | (58 | ) | | | 242 | |
Income taxes receivable/payable | | | 6,701 | | | | 1,263 | |
Accrued interest and other liabilities | | | 7,231 | | | | 3,475 | |
| | | | | | | | |
Net cash provided by operating activities | | | 26,464 | | | | 18,325 | |
Cash flows from investing activities: | | | | | | | | |
Purchase of property and equipment | | | (1,264 | ) | | | (327 | ) |
Acquisition of intangible asset | | | — | | | | (88 | ) |
| | | | | | | | |
Net cash used in investing activities | | | (1,264 | ) | | | (415 | ) |
Cash flows from financing activities: | | | | | | | | |
Long-term debt repayments | | | (7,277 | ) | | | (8,257 | ) |
Dividend paid to parent company | | | — | | | | (1000 | ) |
| | | | | | | | |
Net cash used in financing activities | | | (7,277 | ) | | | (9,257 | ) |
| | | | | | | | |
Net increase in cash and cash equivalents | | | 17,923 | | | | 8,653 | |
Cash and cash equivalents - beginning of period | | | 15,046 | | | | 13,898 | |
| | | | | | | | |
Cash and cash equivalents - end of period | | $ | 32,969 | | | $ | 22,551 | |
| | | | | | | | |
Supplemental cash flow disclosures: | | | | | | | | |
Cash paid for interest | | $ | 2,375 | | | $ | 5,519 | |
| | | | | | | | |
Cash paid for income taxes | | $ | 625 | | | $ | 1,836 | |
| | | | | | | | |
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. The Company and Summary of Significant Accounting Policies
Basis of Presentation
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 three months ended March 31, 2009 and March 31, 2008 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, 2008 of Language Line Holdings, Inc., which are included in the Form 10-K filed with the SEC on March 26, 2009.
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. The year-end balance sheet data was derived from audited financial statements, but does not include all disclosures required by GAAP.
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’s primary revenue source is to provide over-the-phone interpretation services, from English into over 170 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. The Company also performs translation of written media for over 80 different languages.
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 intangible assets, impairment of goodwill and intangible assets, income taxes, and claims and legal proceedings. Actual results could differ from those estimates.
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Principles of Consolidation
The condensed consolidated financial statements include the accounts of LLHI, LLI, LLC and LLC’s wholly-owned subsidiaries as of March 31, 2009 and December 31, 2008, and the results of operations for the three months ended March 31, 2009 and 2008. All significant intercompany accounts and transactions have been eliminated in consolidation.
Goodwill and Other Intangible Assets
The Company accounts for goodwill and other intangible assets in accordance with Statement of Financial Accounting Standards (“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 or whenever events or changes in circumstances indicate that goodwill might be impaired. The Company completed the annual test of impairment for goodwill as of December 31, 2008. These tests resulted in no impairment being recognized. Other intangible assets are generally amortized on a straight-line basis over their useful life which is based on historic experience and plans for utilization of the assets by the Company subsequent to the business combination.
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, if necessary, is provided to reduce net deferred tax assets to an amount that is more likely than not to be realized.
Recent Accounting Pronouncements
In December 2007, the Financial Accounting Standards Board (the “FASB”) issued SFAS No. 141 (Revised 2007), “Business Combinations” (“SFAS 141(R)”). SFAS 141(R) establishes principles and requirements for how an acquirer in a business combination recognizes and measures in its financial statements the identifiable assets acquired, liabilities assumed, and any noncontrolling interests in the acquiree, as well as the goodwill acquired. Significant changes from current practice resulting from SFAS 141(R) include the expansion of the definitions of a “business” and a “business combination.” For all business combinations (whether partial, full or step acquisitions), the acquirer will record 100% of all assets and liabilities of the acquired business, including goodwill, generally at their fair values; contingent consideration will be recognized at its fair value on the acquisition date and, for certain arrangements, changes in fair value will be recognized in earnings until settlement; and acquisition-related transaction and restructuring costs will be expensed rather than treated as part of the cost of the acquisition. SFAS 141(R) also establishes disclosure requirements to enable users to evaluate the nature and financial effects of the business combination. SFAS 141(R) applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. Earlier adoption is not permitted. SFAS 141(R) will likely have an impact on the Company’s consolidated financial statements when effective in the event a business combination occurs. The nature and magnitude of the specific effects will depend upon the nature, terms and size of the acquisition consummated after the effective date.
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurement” (“SFAS 157”), which defines fair value, establishes a framework for measuring fair value under GAAP, and expands disclosure requirements about fair value measurements. SFAS 157 applies to other accounting pronouncements that require or permit fair value measurements. The fair value measurement of financial assets and financial liabilities is effective for us beginning in fiscal year 2008. Three FASB Staff Positions (“FSP”) on this statement were subsequently issued. FSP No. 157-1, issued on February 14, 2008, excluded SFAS No. 13, “Accounting for Leases” (“SFAS 13”), and other accounting pronouncements that address fair value measurements for purposes of lease classification or measurement under SFAS 13. However, this scope exception does not apply to assets acquired and liabilities assumed in a business combination, which are required to be measured at fair value under SFAS No. 141, “Business Combinations” or SFAS 141(R), regardless of whether those assets and liabilities are related to leases. This FSP was effective upon our
5
initial adoption of SFAS 157. FSP No. 157-2, issued on February 12, 2008, delayed the effective date of this statement for non-financial assets and non-financial liabilities that are recognized or disclosed at fair value in the financial statements on a nonrecurring basis. The adoption of FSP No. 157-2 did not have a material impact on our financial statements. FSP No. 157-3, issued in October 2008 and effective upon issuance, clarifies how SFAS 157 should be applied when valuing securities in markets that are not active by illustrating key considerations in determining fair value. Our adoption of this statement on January 1, 2008 is limited to financial assets and liabilities, and did not have a material impact on our consolidated financial position, results of operations or cash flows. In April 2009, the FASB issued FASB Staff Position No. 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly” (“FSP 157-4”). FSP 157-4 provides guidance on determining when the trading volume and activity for an asset or liability has significantly decreased, which may indicate an inactive market, and on measuring the fair value of an asset or liability in inactive markets. We will adopt FSP 157-4 effective April 1, 2009. We do not expect the adoption of FSP 157-4 will have a material impact on our financial statements.
In April 2008, the FASB issued FSP No. 142-3, “Determination of the Useful Life of Intangible Assets” (“FSP 142-3”). This FSP amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under FASB Statement No. 142, Goodwill and Other Intangible Assets. FSP 142-3 applies to intangible assets that are acquired individually or with a group of other assets after the effective date of either a business combination or an asset acquisition. The intent of this FSP is to improve the consistency between the useful life of a recognized intangible asset under Statement 142 and the period of expected cash flows used to measure the fair value of the asset under SFAS 141(R) and other U.S. GAAP. The FSP also contains new disclosure requirements with respect to recognized intangible assets. This FSP is effective for fiscal years beginning after December 15, 2008, and for interim periods within such fiscal years. The adoption of FSP 142-3 may have an impact on our financial statements in the event we acquire intangible assets in either a business combination or asset acquisition. The nature and magnitude of the specific effects will depend upon the nature, terms and size of the business combination or asset acquisition consummated after the effective date.
In April 2009, the FASB issued FSP No. 107-1, “Interim Disclosures about Fair Value of Financial Instruments”, which is effective in the second quarter of 2009. This guidance increases the frequency of fair value disclosures from annual only to quarterly for all financial instruments within the scope of SFAS 107, whether recognized or not on the balance sheet.
Reclassifications
Certain balance sheet amounts in our previously filed financial statements have been reclassified to conform to the current period presentation, as discussed in Note 5.
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 March 31, 2009, a total of approximately $162.8 million of Senior Subordinated Notes were outstanding. The 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.
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.
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4. Related Party Transactions
In January 2008, the Company’s ultimate parent, Language Line Holdings, LLC completed its acquisition of Coto Holdings, LLC (“Coto”), a previously unaffiliated company. As part of an affiliate and intercompany services agreement executed between the Company, its parent and Coto, the Company is to provide certain management, interpretation and other defined services to Coto.
As consideration for these management services, Coto is charged a management fee by the Company equal to $500,000 per quarter. Management fees earned by the Company for the three months ended March 31, 2009 and 2008, included in revenues in the accompanying statements of operations, totaled $500,000 and $445,000, respectively.
Additionally, Coto is charged a fee to reimburse the Company for costs it incurs for providing interpretation services including interpreter labor, telecommunication, interpreter management and other miscellaneous direct costs. Reimbursable charges to Coto for interpretation services, netted against cost of revenues for the three months ended March 31, 2009 and 2008, totaled $5,403,000 and $169,000, respectively. Finally, reimbursable charges to Coto for other miscellaneous (indirect) costs netted against selling, general and administrative expenses totaled $883,000 and $230,000 for the three months ended March 31, 2009 and 2008, respectively. At March 31, 2009, Coto owed the Company an aggregate of $2,917,000 related to these services and charges.
5. Income Taxes
The operations of the Company and subsidiaries are included in the consolidated federal and state income tax returns of its parent, Language Line Holdings, II Inc. The Company and subsidiaries manage the respective tax payments and refunds for Language Line Holdings, II Inc. Included in the accompanying consolidated balance sheet at March 31, 2009 and December 31, 2008 are amounts owed to Language Line Holdings, II Inc. of $1,330,000 and $2,229,000, respectively, under this arrangement. These amounts are presented separately from the amounts that are receivable or payable (from/to) taxing authorities for federal and state income taxes. In prior periods amounts owed to Language Line Holdings, II Inc. were offset against amounts due from/to taxing authorities in the consolidated balance sheet. The Company revised this presentation in the consolidated balance sheet in 2008, and the resulting changes have been reflected in the accompanying consolidated cash flow statement for the three months ended March 31, 2008.
In February 2009, California budget legislation was signed into law that, among other things, contained several state tax law changes that affected the Company’s effective state tax rate. As a result of these changes, the Company re-evaluated its state deferred tax liabilities and assets in the first quarter of 2009, as the effect of changes in tax laws are accounted for in the period the law changed. The impact of these tax law changes reduced the blended state tax rates applied to the Company’s recorded deferred tax liabilities at March 31, 2009, which had the effect of reducing the Company’s income tax provision for the quarter ended March 31, 2009 in the amount of approximately $3.4 million.
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| 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 believe we are the leading global provider of Over-the-phone interpretation (“OPI”) services from English into more than 170 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 proficient (“LEP”) speakers throughout the world. In 2008, we helped more than 35 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 actual billed minutes of service and the customer’s contractual rate per billed minute of service. In addition, the Company generates revenue from complementary services such as document translation, Video Interpretation services, American Sign Language, and face-to-face interpretation. We recognize revenues when the services have been performed.
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, call agents and telecommunications costs.
Recent events, including the fallout from problems in the U.S. credit markets, indicate a moderate to severe recession in the U.S. and world economies, which could have an impact on our customers and the volume of business they are able to conduct with us, as well as the prices we able to charge for our services.
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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
March 31, 2009 | | | Three Months Ended
March 31, 2008 | |
Statement of Operations data: | | | | | | |
Revenues | | 100.0 | % | | 100.0 | % |
Cost of Revenues | | 31.1 | % | | 33.4 | % |
Other expenses: | | | | | | |
Selling, general and administrative | | 19.6 | % | | 17.5 | % |
Interest | | 19.0 | % | | 25.7 | % |
Depreciation and amortization | | 12.2 | % | | 15.1 | % |
| | | | | | |
Total other expenses | | 50.8 | % | | 58.3 | % |
| | | | | | |
Other income: | | | | | | |
Interest | | 0.0 | % | | 0.5 | % |
Other | | 0.1 | % | | 0.7 | % |
| | | | | | |
Total other income | | 0.1 | % | | 1.2 | % |
| | | | | | |
Income before taxes | | 18.2 | % | | 9.5 | % |
Tax on income | | 2.0 | % | | 4.8 | % |
| | | | | | |
Net income | | 16.2 | % | | 4.7 | % |
| | | | | | |
Three Months Ended March 31, 2009 Compared to the Three Months Ended March 31, 2008
Revenues for the three months ended March 31, 2009 were $60.0 million as compared to $48.9 million for the three months ended March 31, 2008, an increase of $11.1 million or 22.7 %. This increase in revenue is driven by principally by an increase in OPI billed minutes, offset partially by a nominal 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 March 31, 2009, cost of services were $18.7 million as compared to $16.3 million for the three months ended March 31, 2008 an increase of $2.4 million or 14.5%. This increase was primarily due to increased interpretation minutes, partially offset by a lower cost per minute as a result of lower interpreter costs.
Selling, general and administrative expenses for the three months ended March 31, 2009 were $11.7 million as compared to $8.6 million for the three months ended March 31, 2008, an increase of $3.2 million or 37.1%. This increase was primarily due to higher sales, marketing and corporate expenses of $2.7 million, coupled with increases in other selling, general and administrative expenses.
Interest expense for the three months ended March 31, 2009 was $11.4 million as compared to $12.6 million for the three months ended March 31, 2008, a decrease of $1.1 million or 9.1%. This was primarily due to a decrease in the interest rate on our senior secured debt (at March 31, 2009 the rate was 4.47% as compared to 5.95% at March 31, 2008), combined with a lower average principal balance during the period for this senior secured debt.
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Depreciation and amortization was $7.3 million for the three months ended March 31, 2009, principally unchanged from the same amount recorded for the three months ended March 31, 2008.
Interest income for the three months ended March 31, 2009 was $0 million as compared to $0.3 million for the three months ended March 31, 2008, due to a decline in the rate of interest earned on deposits.
Tax expense on income for the three months ended March 31, 2009 was $1.2 million as compared to $2.4 million for the three months ended March 31, 2008, a decrease of $1.2 million. The effective tax rate for the quarter ended March 31, 2009 was 11.2% as compared to 50.7% for the quarter ended March 31, 2008. In February 2009, California budget legislation was signed into law that, among other things, contained several state tax law changes that affected the Company’s effective state tax rate. As a result of these changes, the Company re-evaluated its state deferred tax liabilities and assets in the first quarter of 2009, as the effect of changes in tax laws are accounted for in the period the law changed. The impact of these tax law changes reduced the blended state tax rates applied to the Company’s recorded deferred tax liabilities at March 31, 2009, which had the effect of reducing the Company’s income tax provision for the quarter ended March 31, 2009 in the amount of approximately $3.4 million.
As a result of the factors described above, net income was $9.7 million for the three months ended March 31, 2009 as compared to $2.3 million for the three months ended March 31, 2008.
Liquidity and Capital Resources
Operating Activities. Net cash provided by operating activities for the three months ended March 31, 2009 was $26.5 million. This reflects net income of $9.7 million, non-cash charges of $11.9 million, and cash provided by operating assets and liabilities (net) of $10.1 million, offset by a decrease in deferred income taxes of $5.2 million. Non-cash charges include depreciation and amortization, amortization of deferred financing costs, accretion of discount on long-term debt, and stock based compensation. Net cash provided by operating activities for the three months ended March 31, 2008 was $18.3 million. This reflects net income of $2.3 million, non-cash charges of $11.4 million, cash provided by operating assets and liabilities (net) of $6.1 million, offset by a decrease in deferred income taxes of $1.5 million.
Investing Activities. Net cash used in investing activities was $1.3 million for the three months ended March 31, 2009. This reflects capital expenditures of $1.3 million for the period. Net cash used in investing activities was $0.4 million for the three months ended March 31, 2008. This reflects principally capital expenditures of $0.3 million for the period.
Financing Activities. Net cash used in financing activities for the three months ended March 31, 2009 was $7.3 million, reflecting payments made on our senior secured debt of $7.3 million. Net cash used in financing activities for the three months ended March 31, 2008 was $9.3 million. This reflects payments made on our senior secured debt of $8.3 million and a dividend distribution in the amount of $1.0 million to Language Line Holding II, Inc. an affiliated non-consolidated entity under the ultimate parent, Language Line Holdings, LLC. At March 31, 2009 the maximum amount available under the revolving credit facility was $40.0 million, and no balance was outstanding.
Debt Service. As of March 31, 2009, we had total indebtedness of $463.2 million and $40 million of borrowings available under our revolver credit facility, as defined in our loan agreement of which $0 is outstanding.
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 senior 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.
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On June 11, 2004 Language Line, Inc. 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. 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.
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, are subordinate to the Notes described above, and 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.
Capital Expenditures. We expect to spend approximately $4.0 million in 2009 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.
Our principal sources of liquidity are cash flow from operations and borrowings available under our revolver credit facility. We believe that these funds will be sufficient to meet our debt service, capital expenditures and working capital requirements for the next twelve months. 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.
Recent events, including the fallout from problems in the U.S. credit markets, indicate a moderate to severe recession in the U.S. and world economies, which could have an impact on our customers and the volume of business they are able to conduct with us, as well as the prices we able to charge for our services. Additionally, the securities and credit markets have recently been experiencing volatility and disruption, which could impact our ability to access capital. Our principal sources of liquidity are cash flow from operations and borrowings available under our revolver credit facility. We believe that these funds will be sufficient to meet our debt service, capital expenditures and working capital requirements. 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. However, we believe the lenders participating in our revolver credit facility will be willing and able to provide financing in accordance with the terms of the agreement, and to date, our access to credit under our revolving credit facility has not been adversely affected by recent market conditions. Finally, we monitor the financial strength of our third-party financial institutions, including those that hold our cash, and attempt to diversify our concentration of cash that we hold at any point in time.
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Contractual and Commercial Commitments Summary
The following tables present our long-term contractual cash obligations as of March 31, 2009 (dollars in thousands):
| | | | | | | | | | | | | | | | | | | | | | | | |
| | | Total | | 2009 | | 2010 | | 2011 | | 2012 | | 2013 | | Thereafter | | Other |
Senior secured credit facilities | | | 194,398 | | $ | 9,054 | | $ | 12,071 | | $ | 173,273 | | $ | — | | $ | — | | $ | — | | $ | — |
Senior subordinated notes offered by Language Line, Inc. | | | 165,000 | | | — | | | — | | | — | | | 165,000 | | | | | | — | | | — |
Senior discount notes | | | 108,993 | | | — | | | — | | | — | | | — | | | 108,993 | | | — | | | — |
Interest payments | | | 144,165 | | | 32,470 | | | 41,834 | | | 37,590 | | | 24,573 | | | 7,698 | | | — | | | — |
Unrecognized tax benefits | | | 1,128 | | | 375 | | | — | | | — | | | — | | | — | | | — | | | 753 |
Operating leases | | | 2,046 | | | 887 | | | 983 | | | 176 | | | — | | | — | | | — | | | — |
Service Contract Commitments | | | 8,633 | | | 2,775 | | | 3,700 | | | 2,158 | | | — | | | — | | | — | | | — |
| | | | | | | | | | | | | | | | | | | | | | | | |
Total cash contractual obligations | | $ | 624,363 | | $ | 45,561 | | $ | 58,588 | | $ | 213,197 | | $ | 189,573 | | $ | 116,691 | | $ | — | | $ | 753 |
| | | | | | | | | | | | | | | | | | | | | | | | |
Interest payments with respect to the senior secured credit facilities assume a variable rate (4.47% at March 31, 2009), which represents the most recent rate applicable to these facilities. 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.
Related Party Transactions
In January 2008, the Company’s ultimate parent, Language Line Holdings, LLC completed its acquisition of Coto Holdings, LLC (“Coto”), a previously unaffiliated company. As part of an affiliate and intercompany services agreement executed between the Company, its parent and Coto, the Company is to provide certain management, interpretation and other defined services to Coto.
As consideration for these management services, Coto is charged a management fee by the Company equal to $500,000 per quarter. Management fees earned by the Company for the three months ended March 31, 2009 and 2008, included in revenues in the accompanying statements of operations, totaled $500,000 and $445,000, respectively.
Additionally, Coto is charged a fee to reimburse the Company for costs it incurs for providing interpretation services including interpreter labor, telecommunication, interpreter management and other miscellaneous direct costs. Reimbursable charges to Coto for interpretation services, netted against cost of revenues for the three months ended March 31, 2009 and 2008, totaled $5,403,000 and $169,000, respectively. Finally, reimbursable charges to Coto for other miscellaneous (indirect) costs netted against selling, general and administrative expenses totaled $883,000 and $230,000 for the three months ended March 31, 2009 and 2008, respectively. At March 31, 2009, Coto owed the Company an aggregate of $2,917,000 related to these services and charges.
Income Taxes
The operations of the Company and subsidiaries are included in the consolidated federal and state income tax returns of its parent, Language Line Holdings, II Inc. The Company and subsidiaries manage the respective tax payments and refunds for Language Line Holdings, II Inc. Included in the accompanying consolidated balance sheet at March 31, 2009 and December 31, 2008 are amounts owed to Language Line Holdings, II Inc. of $1,330,000 and $2,229,000, respectively, under this arrangement. These amounts are presented separately from the amounts that are receivable or payable (from/to) taxing authorities for federal and state income taxes. In prior periods amounts owed to Language Line Holdings, II Inc. were offset against amounts due from/to taxing authorities in the balance sheet. The Company revised this presentation in the consolidated balance sheet in 2008, and the resulting changes have been reflected in the accompanying consolidated cash flow statement for the three months ended March 31, 2008.
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In February 2009, California budget legislation was signed into law that, among other things, contained several state tax law changes that affected the Company’s effective state tax rate. As a result of these changes, the Company re-evaluated its state deferred tax liabilities and assets in the first quarter of 2009, as the effect of changes in tax laws are accounted for in the period the law changed. The impact of these tax law changes reduced the blended state tax rates applied to the Company’s recorded deferred tax liabilities at March 31, 2009, which had the effect of reducing the Company’s income tax provision for the quarter ended March 31, 2009 in the amount of approximately $3.4 million.
Critical Accounting Policies
Financial statement preparation requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses and disclosure of contingent assets and liabilities. The accompanying consolidated unaudited financial statements are prepared using the same critical accounting policies discussed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2008.
| 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, 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 March 31, 2009, we had $274.0 million principal amount of fixed-rate debt and $234.4 million of available floating-rate debt (of which we borrowed $194.4 million). Based on the 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 $1.9 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. |
| (a) | Evaluation of disclosure controls and procedures. Based on the evaluation of our disclosure controls and procedures (as defined in Securities Exchange Act of 1934 Rules 13a-15(e) and 15d-15(e)) required by Securities Exchange Act Rules 13a-15(b) or 15d-15(b), our Chief Executive Officer and our Chief Financial Officer have concluded that as of the end of the period covered by this report, our disclosure controls and procedures were effective. |
| (b) | Changes in internal controls. There were no changes in our internal control over financial reporting that occurred during our most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. |
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PART 2. OTHER INFORMATION
Language Line Holdings, Inc. is not currently involved in any material legal proceedings.
There have been no material changes in our risk factors from those disclosed in Item 1A of Part I of our Annual Report on Form 10-K for the fiscal year ended December 31, 2008.
| Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds |
None
| 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 May 8, 2009.
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| LANGUAGELINE HOLDINGS, INC. |
|
| /s/ Dennis G. Dracup |
Dennis G. Dracup |
Chief Executive Officer and Director |
|
|
| /s/ Michael F. Schmidt |
Michael F. Schmidt |
Chief Financial Officer and Secretary |
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