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 June 30, 1999
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 1-10390
Berlitz International, Inc.
---------------------------
(Exact name of registrant as specified in its charter)
New York 13-355-0016
-------- -----------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
400 Alexander Park, Princeton, New Jersey 08540-6306
----------------------------------------------------
(Address of principal executive offices)
(609) 514-9650
--------------
Registrant's telephone number, including area code
N/A
---------------------------------------------------
Former name, former address and former fiscal year,
if changed since last report
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
The number of shares outstanding of the registrant's common stock, at the close
of business on August 13, 1999, is 9,529,788.
Page 1 of 36
<PAGE>
PART I. FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
BERLITZ INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
FOR THE THREE MONTHS ENDED JUNE 30
(Dollars in thousands, except per share amounts)
1999 1998
--------- ---------
Sales of services and products $ 111,182 $ 107,509
--------- ---------
Costs and expenses:
Cost of services and products sold 66,072 63,161
Selling, general and administrative 36,556 33,750
Amortization of publishing rights, excess of cost
over net assets acquired, and other intangibles 4,369 4,276
Interest expense on long-term debt 20 2,768
Interest expense on Convertible Debentures
with related parties 2,004 --
Interest expense on notes to affiliates 648 549
Other expense, net 80 789
--------- ---------
Total costs and expenses 109,749 105,293
--------- ---------
Income before income taxes, minority
interest in (loss) earnings of subsidiary, and
extraordinary item 1,433 2,216
Income tax expense 1,811 1,479
Minority interest in (loss) earnings
of subsidiaries (60) 37
--------- ---------
(Loss) income before extraordinary item (318) 700
Extraordinary loss from extinguishment
of debt 4 --
--------- ---------
Net (loss) income $ (322) $ 700
========= =========
(Loss) income per share - basic and diluted
(Loss) income before extraordinary item $ (0.03) $ 0.07
Extraordinary loss -- --
--------- ---------
(Loss) income per share $ (0.03) $ 0.07
========= =========
Average number of shares outstanding (000's) 9,530 9,530
========= =========
See accompanying Notes to the Consolidated Financial Statements.
2
<PAGE>
BERLITZ INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
FOR THE SIX MONTHS ENDED JUNE 30
(Dollars in thousands, except per share amounts)
1999 1998
-------- --------
Sales of services and products $215,544 $212,165
-------- --------
Costs and expenses:
Cost of services and products sold 130,789 126,397
Selling, general and administrative 72,587 67,581
Amortization of publishing rights, excess of cost
over net assets acquired, and other intangibles 8,722 8,615
Interest expense on long-term debt 1,873 5,617
Interest expense on Convertible Debentures
with related parties 2,435 --
Interest expense on notes to affiliates 1,236 1,091
Other (income) expense, net (885) 351
-------- --------
Total costs and expenses 216,757 209,652
-------- --------
(Loss) income before income taxes, minority
interest in (loss) earnings of subsidiary, and
extraordinary item (1,213) 2,513
Income tax expense 1,973 1,684
Minority interest in (loss) earnings
of subsidiaries (179) 106
-------- --------
(Loss) income before extraordinary item (3,007) 723
Extraordinary loss from extinguishment of
debt, net of income tax benefit of $44 2,144 --
-------- --------
Net (loss) income $ (5,151) $ 723
======== ========
(Loss) income per share - basic and diluted
(Loss) income before extraordinary item $ (0.32) $ 0.08
Extraordinary loss (0.22) --
-------- --------
(Loss) income per share $ (0.54) $ 0.08
======== ========
Average number of shares outstanding (000's) 9,530 9,530
======== ========
See accompanying Notes to the Consolidated Financial Statements.
3
<PAGE>
BERLITZ INTERNATIONAL, INC.
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
<TABLE>
<CAPTION>
(Unaudited)
June 30, December 31,
1999 1998
--------- ---------
<S> <C> <C>
ASSETS
Current assets:
Cash and temporary investments $ 28,215 $ 25,327
Accounts receivable, less allowance for
doubtful accounts of $2,540 and $2,295 47,606 46,650
Unbilled receivables 10,399 6,873
Inventories, net 10,493 11,606
Prepaid expenses and other current assets 7,679 7,965
--------- ---------
Total current assets 104,392 98,421
Property and equipment, net of accumulated
depreciation of $26,590 and $25,530 43,880 41,144
Publishing rights, net of accumulated amorti-
zation of $5,643 and $5,203 16,342 16,782
Excess of cost over net assets acquired and other intangibles,
net of accumulated amortization of $82,620 and $75,573 482,773 486,232
Other assets 23,220 20,882
--------- ---------
Total assets $ 670,607 $ 663,461
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt $ 1,007 $ 20,135
Accounts payable 10,777 11,280
Deferred revenues 42,369 41,603
Payrolls and commissions 13,534 15,079
Income taxes payable 1,047 365
Interest payable on convertible debentures 1,938 --
Accrued expenses and other current liabilities 19,257 17,255
--------- ---------
Total current liabilities 89,929 105,717
Long-term debt 5,598 129,387
Convertible debentures with related parties 155,000 --
Notes payable to affiliates 50,000 42,755
Other liabilities 18,290 20,333
Minority interest 10,104 10,283
--------- ---------
Total liabilities 328,921 308,475
--------- ---------
Shareholders' equity:
Common stock 1,003 1,003
Additional paid-in capital 372,518 372,518
(Accumulated deficit) retained earnings (578) 4,574
Treasury stock at cost (6,361) (6,361)
Accumulated other comprehensive loss:
Cumulative translation adjustment (24,896) (16,748)
--------- ---------
Total shareholders' equity 341,686 354,986
--------- ---------
Total liabilities and shareholders' equity $ 670,607 $ 663,461
========= =========
</TABLE>
See accompanying Notes to the Consolidated Financial Statements.
4
<PAGE>
BERLITZ INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(Unaudited)
(Dollars in thousands)
Three months ended June 30,
---------------------------
1999 1998
------- -------
Net (loss) income $ (322) $ 700
Other comprehensive loss, net of tax:
Foreign currency items, including translation
adjustments, and the effects of certain
hedges and intercompany transactions (1,915) (1,308)
------- -------
Comprehensive loss $(2,237) $ (608)
======= =======
The tax expense allocated to each component of other comprehensive loss is as
follows:
Foreign currency items $ 433 $ 442
======= =======
Six months ended June 30,
-------------------------
1999 1998
-------- --------
Net (loss) income $ (5,151) $ 723
Other comprehensive loss, net of tax:
Foreign currency items, including translation
adjustments, and the effects of certain
hedges and intercompany transactions (8,148) (2,806)
-------- --------
Comprehensive loss $(13,299) $ (2,083)
======== ========
The tax expense allocated to each component of other comprehensive loss is as
follows:
Foreign currency items $ 1,185 $ 947
======== ========
See accompanying Notes to the Consolidated Financial Statements.
5
<PAGE>
BERLITZ INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
FOR THE SIX MONTHS ENDED JUNE 30,
(Dollars in thousands)
<TABLE>
<CAPTION>
1999 1998
--------- ---------
<S> <C> <C>
Cash flows from operating activities:
Net (loss) income $ (5,151) $ 723
Adjustments to reconcile net (loss) income to net cash
provided by operating activities:
Depreciation and amortization 14,086 13,384
Other (primarily provision for bad debts and foreign
Exchange gains) (648) 1,160
Changes in operating assets and liabilities (1,892) 4,410
--------- ---------
Net cash provided by operating activities 6,395 19,677
--------- ---------
Cash flows from investing activities:
Capital expenditures (10,565) (8,506)
Acquisitions of businesses (8,373) (3,347)
--------- ---------
Net cash used in investing activities (18,938) (11,853)
--------- ---------
Cash flows from financing activities:
Proceeds from issuance of Convertible Debentures 155,000 --
Proceeds from issuance of note payable to affiliate 50,000 --
Net borrowings under revolving credit facility 4,000 4,000
Repayment of long-term debt (146,899) (8,509)
Repayment of notes to affiliates (42,366) --
Payment of deferred finance costs (2,782) (177)
--------- ---------
Net cash provided by (used in) financing activities 16,953 (4,686)
--------- ---------
Effect of exchange rate changes on cash and
temporary investments (1,522) (510)
--------- ---------
Net increase in cash and temporary investments 2,888 2,628
Cash and temporary investments, beginning of period 25,327 26,665
--------- ---------
Cash and temporary investments, end of period $ 28,215 $ 29,293
========= =========
Supplemental disclosures of cash flow information:
Cash payments for:
Interest $ 3,084 $ 5,442
========= =========
Income taxes $ 2,898 $ 4,544
========= =========
Cash refunds of income taxes $ 417 $ 666
========= =========
</TABLE>
See accompanying Notes to the Consolidated Financial Statements.
6
<PAGE>
BERLITZ INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except per share amounts)
1. General
The Consolidated Financial Statements of Berlitz International, Inc. (the
"Company" or "Berlitz") have been prepared in accordance with the
instructions to Form 10-Q and are unaudited. The information reflects all
adjustments of a normal recurring nature which are, in the opinion of
management, necessary for a fair presentation of such financial statements.
The financial statements should be read in conjunction with the financial
statements and related notes to the Company's 1998 Annual Report on Form
10-K, as filed with the Securities and Exchange Commission.
Reclassifications
Certain reclassifications have been made in the prior years' notes to
conform with the 1999 presentation.
2. Long-Term Debt
Long-term debt consists of the following:
June 30, December 31,
1999 1998
-------- --------
Term Loan $ -- $ 98,250
Revolving credit facility 4,000 48,000
Other 2,605 3,272
-------- --------
Total 6,605 149,522
Less current maturities 1,007 20,135
-------- --------
Long-term debt $ 5,598 $129,387
======== ========
As discussed in Notes 3 and 4, on March 11, 1999, the Company issued
Convertible Debentures, as well as a promissory note to Benesse Holdings
International, Inc. ("BHI"), and used a portion of the resulting proceeds
to repay in full all outstanding indebtedness under the Term Loan and
revolving credit facility (collectively, the "Bank Facility"). The existing
Bank Facility was then terminated.
On March 31, 1999, the Company entered into a new $25,000 revolving credit
facility (the "Revolving Facility"), which expires in February 2002. At the
option of the Company, outstanding borrowings under the Revolving Facility
bear interest at variable rates equal to either (i) a base rate
approximating the U.S. prime rate or (ii) the rate offered by certain
reference banks to prime banks in the interbank Eurodollar market, fully
adjusted for reserves plus a margin ranging from 0.375% to 0.5%; such
margin is dependent on a specified leverage ratio of the Company. In
addition, a commitment fee ranging from .125% to .20% will be charged on
the available but unused amounts under the revolving credit facility,
depending on a specified leverage ratio. There were $4,000 in outstanding
borrowings under the Revolving Facility at June 30, 1999. The average
interest rate on outstanding borrowings under the revolving facility for
the period ending June 30, 1999 was 5.725%.
7
<PAGE>
The Revolving Facility is subject to standard affirmative covenants,
including financial and other informational reporting, compliance with
laws, maintenance of insurance, maintenance of properties, payment of
taxes, and preservation of corporate existence. The Revolving Facility also
includes limitations on the ability of the Company and its subsidiaries to:
(i) enter into mergers, acquisitions or sales of assets; (ii) incur, create
or permit to exist liens; (iii) incur indebtedness and guarantee
obligations; (iv) make loans or investments; (v) enter into transactions
with affiliates; (vi) prepay subordinated indebtedness; and (vii) change
the nature of the business conducted. Financial covenants included within
the Revolving Facility require the Company to maintain certain levels of
cash flow and impose limitations on total and senior debt.
3. Convertible Debentures with Related Parties
On March 11, 1999 (the "Issue Date"), the Company's shareholders approved
the issuance of, and the Company issued, $155,000 aggregate principal
amount 12-year convertible debentures (the "Convertible Debentures") in a
private placement, pursuant to definitive investment agreements (the
"Investment Agreements") dated as of October 2, 1998. The Convertible
Debentures were issued as follows: a) $100,000 aggregate principal amount
(the "Apollo Debentures") to two affiliates of Apollo Management IV, L.P.
("Apollo"), a private investment firm; and b) $55,000 aggregate principal
amount (the "Benesse Debentures") to BHI, the Company's majority
shareholder. The Convertible Debentures bear interest at 5% per annum,
payable semi-annually. Principal amounts outstanding under such debentures
are not due until March 2011, and the Company is not required to establish
a bond sinking fund for repayment of this principal.
The Convertible Debentures are convertible at any time into shares of the
Company's common stock at a conversion price of $33.05 per share, subject
to anti-dilution related adjustments to offset the effects of stock
dividends and other changes in equity. The Company will, at all times,
reserve out of its authorized but unissued common stock the full number of
shares then issuable upon conversion of all outstanding Convertible
Debentures.
The Apollo and Benesse Debentures each independently provide for optional
redemption by the Company, in whole but not in part, anytime following 60
trading days after the third anniversary of the Issue Date. If the average
closing price of the Company's common stock for the 30 trading days
following the third anniversary of the Issue Date exceeds $39.66 per share,
the Company may redeem at par. Otherwise, if the Convertible Debentures are
redeemed, the Company shall pay a redemption premium, expressed as a
percentage of outstanding principal, as follows: a) 4% for redemptions
occurring in the fourth year after issue; b) 2% for redemptions occurring
in the fifth year after issue; and c) 0% for redemptions occurring
thereafter. All such redemptions are subject to the holders' rights to
first convert into common stock of the Company.
The Convertible Debentures also allow Apollo and BHI to elect to exchange
their convertible debentures, in whole, into non-convertible, 7-year fixed
rate debt (the "Fixed Rate Debentures"). Such election may only be made if
the average closing price of the Company's common stock during the 30
trading days immediately preceding the third anniversary of the Issue Date
does not exceed $33.05.
8
<PAGE>
Furthermore, BHI may only effect an exchange if Apollo does so. Upon the
determination, by an independent financial institution, of fixed interest
rates that accurately price the Fixed Rate Debentures at par under
specified circumstances at the time of the exchange, Apollo and BHI shall
irrevocably decide whether to proceed with their exchanges. If only Apollo
proceeds with such an exchange, the Company, no later than 150 days from
the third anniversary of the Issue Date, must either a) redeem all of the
Apollo Debentures at par, or b) deliver the Fixed Rate Debentures to
Apollo. If both Apollo and BHI proceed with their exchanges, the Company,
within the same 150 day period, shall either a) redeem both the Apollo and
Benesse Debentures, or b) deliver the Fixed Rate Debentures to both Apollo
and BHI.
Principal amounts outstanding under the Fixed Rate Debentures would not be
payable until maturity, while interest payments would be made
semi-annually. The Fixed Rate Debentures interest rate is subject to a cap
of a) the applicable U.S. treasury rate + 5% (not to exceed 13%) if only
Apollo receives Fixed Rate Debentures, or b) the applicable U.S. treasury
rate + 7% (not to exceed 14%) if both Apollo and BHI receives Fixed Rate
Debentures. The Fixed Rate Debentures may be redeemed by the Company after
the third anniversary of their issue upon payment of principal amounts of
the Fixed Rate Debentures and the following redemption premiums, expressed
as a percentage of the outstanding principal amount: a) one half of the per
annum interest rate for redemptions occurring in the fourth year after
issue; b) one quarter of the per annum interest rate for redemptions
occurring in the fifth year after issue; and c) no premium for redemptions
occurring thereafter.
Prior to the third anniversary of the Issue Date, if Benesse sells 80% or
more of the shares of Berlitz common stock owned directly or indirectly by
it on the Issue Date, the Company shall be required to make an offer to
repurchase for cash: i) the Apollo Debentures at a value equal to 110% of
the principal amount then outstanding; and ii) the Benesse Debentures at a
value equal to 101% of the principal amount then outstanding. In addition,
if at any time on or after the Issue Date, a change of control, as defined
in the Investment Agreements, occurs but Benesse sells less than 80% of its
shares, or if Benesse sells 80% of its shares on or after the third
anniversary of the Issue Date, the Company shall be required to make an
offer to repurchase for cash the Convertible Debentures (but not the Fixed
Rate Debentures) at a value equal to 101% of the principal amount of the
Convertible Debentures.
The Convertible Debentures are subject to standard affirmative covenants,
including financial and other informational reporting, compliance with
laws, maintenance of insurance, maintenance of properties, payment of
taxes, and preservation of corporate existence. Negative covenants that the
Convertible Debentures are subject to include: prohibitions on certain
mergers, consolidations and asset transfers; forbearance from restrictions
on rights of holders to convert or exchange the Convertible Debentures;
and, in the case of the Apollo Debentures, forbearance from amending
certain understandings between the Company, Berlitz Japan, Inc. and
Benesse.
The Investment Agreements include a number of other provisions, including:
a) the granting of certain demand and piggyback registration rights to the
holders of the Convertible Debentures; b) the granting of a certain number
of board seats to Apollo on the Company's Board of Directors; c) the
granting of approval rights to Apollo, at
9
<PAGE>
the Company's Board level, over certain transactions; and d) certain
restrictions on the transferability of the Apollo Debentures. The Company
expanded its Board of Directors from 10 seats to 12 seats effective March
11, 1999 and appointed two representatives of Apollo to the Board.
The estimated fair value of the Convertible Debentures in March 1999, the
month of issuance, was $142,600. This estimate was based on the then
current interest rates and Berlitz stock price volatility.
4. Transactions with Affiliates
On March 11, 1999, BHI loaned $50,000 to the Company, evidenced by a
12-year fixed rate subordinated promissory note (the "BHI Note"). Such note
bears interest for the first five years at 5.2% per annum, and, thereafter,
at a renegotiated fixed rate approximating LIBOR plus a margin based on the
Company's then existing leverage. Interest is payable semiannually in cash
while principal repayment is deferred until maturity. The BHI Note includes
standard covenants similar to those included in the Benesse Debentures. In
the event of a change in control, the BHI Note provides for redemption by
the Company, at the option of BHI, at a price equal to 101% of the note's
principal amount.
The estimated fair value of the BHI Note in March 1999, the month of
issuance, was $31,955, based on interest rates then currently available for
borrowings with similar terms and maturities.
The Company has used a portion of the proceeds from the issuance of the BHI
Note and Convertible Debentures to repay in full the existing notes payable
to affiliates.
The Company incurred approximately $2,800 in deferred finance costs
associated with the issuance of the Convertible Debentures and BHI Note.
Such costs will be amortized over the 12-year life of the Convertible
Debentures and BHI Note.
5. Extraordinary Loss
On March 11, 1999, in connection with the issuance of the Convertible
Debentures and BHI Notes and the extinguishment of the Bank Facility, the
Company terminated its interest rate swap agreement, which hedged the
floating rate Bank Facility, for a cash payment of approximately $1,100. As
a consequence of the debt extinguishment, the Company has recorded an
extraordinary loss, net of tax benefit, of $2,144, consisting primarily of
the interest rate swap's fair market value and existing unamortized
deferred finance costs at the time of extinguishment of the underlying
debt.
6. Other (Income) Expense, net
Three months Three months
ended ended
June 30, 1999 June 30, 1998
------------- -------------
Interest income on temporary investments $(166) $(165)
Foreign exchange (gains) losses, net (294) 633
Other non-operating taxes 111 33
Loss on disposal of fixed assets 103 91
Other investment expense (income), net 72 (48)
Other expense, net 254 245
----- -----
Total other expense, net $ 80 $ 789
===== =====
10
<PAGE>
Six months Six months
ended ended
June 30, 1999 June 30, 1998
------------- -------------
Interest income on temporary investments $ (257) $ (310)
Foreign exchange (gains) losses, net (1,202) 215
Other non-operating taxes 231 107
Loss on disposal of fixed assets 122 207
Other expense, net 221 132
------- -------
Total other (income) expense, net $ (885) $ 351
======= =======
7. Earnings (Loss) Per Share
Reconciliations between Basic and Diluted earnings (loss) per share ("EPS")
computations for "income (loss) before extraordinary item" for the three
and six months ended June 30, 1999 and 1998 are as follows:
Weighted
average
number
(Loss) of shares Per-share
Income outstanding amount
Three months ending June 30, 1999:
Basic EPS:
Loss before extraordinary item $ (322) 9,530 $(0.03)
Effect of dilutive securities:
Stock options -- -- --
------- ------- ------
Diluted EPS:
Loss before extraordinary item $ (322) 9,530 $(0.03)
======= ======= ======
Three months ending June 30, 1998:
Basic EPS:
Income before extraordinary item $ 700 9,530 $ 0.07
Effect of dilutive securities:
Stock options -- 36 --
------- ------- ------
Diluted EPS:
Income before extraordinary item $ 700 9,566 $ 0.07
======= ======= ======
Six months ending June 30, 1999:
Basic EPS:
Loss before extraordinary item $(5,151) 9,530 $(0.54)
Effect of dilutive securities:
Stock options -- -- --
------- ------- ------
Diluted EPS:
Loss before extraordinary item $(5,151) 9,530 $(0.54)
======= ======= ======
Six months ending June 30, 1998:
Basic EPS:
Income before extraordinary item $ 723 9,530 $ 0.08
Effect of dilutive securities:
Stock options -- 27 --
------- ------- ------
Diluted EPS:
Income before extraordinary item $ 723 9,557 $0.08
======= ======= ======
11
<PAGE>
8. Stock Option and Incentive Plans
In 1999, the Company paid $2,855 in awards under its 1996 New Long-Term
Executive Incentive Compensation Plan.
In June 1999, the Company's shareholders approved the adoption of the
Berlitz 1999 Long-Term Executive Incentive Compensation Plan (the "1999
LTIP"). The 1999 LTIP provides for potential cash awards (currently
expected to range from $0 to $7,200 in the aggregate) to be paid to senior
management in 2002 if certain revenue, earnings and cash flow targets are
achieved for the three-year period from 1999 to 2001. The 1999 LTIP is
intended to be an unfunded plan, and the Company is not required to
establish any fund or segregate any assets for payments under it. For the
three and six months ended June 30, 1999, the Company recorded $183 in
expense related to the 1999 LTIP.
9. Acquisitions of businesses
In June 1999, the Company acquired certain assets, operating subsidiaries
and key personnel of Language Management International, Inc., a
translations services company. The purchase price was $7,750, plus a
contingent payment based on gross revenues for the twelve months ending
June 30, 2000. The Company also incurred various transaction-related
expenditures and accrued expenses. At June 30, 1999, in connection with
this acquisition, the Company recorded $11,800 of goodwill and $4,000 of
accrued current liabilities for transaction-related expenses and
contingencies.
The Company made several other acquisitions during the first six months,
none of which were material.
10. Subsequent events
On July 1, 1999, Berlitz entered into a license agreement (the "Agreement")
with Children's Television Workshop ("CTW"). Pursuant to this license
agreement, CTW has agreed to create and produce, at its expense, a
television series, entitled "Sesame English", which will initially consist
of 52 15-minute episodes which will be complemented by instruction
curricula and materials developed by Berlitz. In addition, Berlitz was
granted certain rights by CTW, including the exclusive right to use certain
Sesame Street and Sesame English names, logos and characters in connection
with language instructional products, services and schools.
The Agreement, covering an initial term of five years, provides for
payments to CTW of $4,000 at inception and an aggregate of $6,000 in
minimum guaranteed royalties paid in installments over the initial term of
the agreement. In the event that Berlitz enters into any sublicenses or
other third-party arrangements with a sublicensee for language instruction
services in Japan, such minimum guaranteed royalties shall be
12
<PAGE>
reduced dollar for dollar, up to a maximum of $2,000, from CTW's share of
payments from such Japanese sublicensees. If certain conditions are met,
Berlitz may extend the Agreement for another five years in exchange for
annual minimum guaranteed royalties equal to the greater of $2,000, or an
amount equal to 80% of the royalties earned by CTW during the fifth year of
the initial term.
As part of its CTW and general marketing efforts, Berlitz is in the process
of pursuing opportunities to expand the use of the Internet for the
marketing and distribution of its products and services.
11. Operating Segments
Effective January 1, 1999, the Company's operations are principally
conducted through two segments: Language Services (consisting of the
Instruction, ELS/BOC (i.e., ELS Educational Services, Inc. ("ELS") and
Berlitz on Campus ("BOC")), Publishing, Franchising, and Cross Cultural
sub-segments), and Berlitz GlobalNET (formerly Translation Services). These
are strategic business units that offer different products and services and
are managed separately by senior management due to different technology and
marketing strategies.
Within Language Services, the Instruction sub-segment (through the use of
proprietary methods and materials) provides predominantly live language
education in virtually all spoken languages. The ELS/BOC sub-segment
provides intensive English education programs. The Publishing sub-segment
offers a wide range of publishing products such as dictionaries, phrase
books, travel guides and self-study language materials, including CD-ROMs
and audiocassettes. The Franchising sub-segment sells Berlitz language
center franchises to independent franchisees in certain locations. The
Cross Cultural sub-segment complements language study by providing
expatriates with detailed practical and cultural information about the
countries to which they are relocating.
Berlitz GlobalNET provides high quality technical documentation
translation, software localization (i.e., the translation of
software-related products), software quality assurance testing,
interpretation services, electronic publishing services, and other foreign
language-related services.
The Company evaluates operating segment performance based on EBITA, defined
as sales of services and products, less costs of services and products sold
and selling, general and administrative expenses. EBITA includes
depreciation and similar non-cash charges, but excludes amortization of
publishing rights, excess of cost over net assets acquired, and other
intangibles.
The following tables present information about reported segment profit or
loss and segment assets, and reconcile reportable segment revenues, profit
or loss, and assets to the Company's consolidated totals:
13
<PAGE>
<TABLE>
<CAPTION>
Three Months ended June 30, Six Months ended June 30,
--------------------------- -------------------------
1999 1998 1999 1998
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Revenues:
Revenues from external customers:
Language Services:
Instruction $ 69,863 $ 68,568 $ 136,264 $ 133,667
ELS/BOC 12,403 13,950 24,876 29,037
Publishing 4,126 3,386 7,214 6,954
Franchising 469 368 709 601
Cross Cultural 645 601 1,232 1,183
Other (1) 3 (2) 9
--------- --------- --------- ---------
Total Language Services 87,505 86,876 170,293 171,451
Berlitz GlobalNET 23,677 20,633 45,251 40,714
--------- --------- --------- ---------
Total external revenues 111,182 107,509 215,544 212,165
--------- --------- --------- ---------
Intersegment revenues:
Language Services:
Instruction -- 7 -- 16
Franchising 125 262 238 346
--------- --------- --------- ---------
Total Language Services 125 269 238 362
Berlitz GlobalNET 35 13 44 13
--------- --------- --------- ---------
--------- --------- --------- ---------
Total intersegment revenues 160 282 282 375
--------- --------- --------- ---------
Total revenues for reportable segments 111,342 107,791 215,826 212,540
Elimination of intersegment revenues (160) (282) (282) (375)
--------- --------- --------- ---------
Total consolidated revenues $ 111,182 $ 107,509 $ 215,544 $ 212,165
========= ========= ========= =========
(Loss) income before taxes, minority interest,
and extraordinary item:
Operating Profit:
Segment EBITA:
Language Services:
Instruction $ 14,777 $ 15,831 $ 26,658 $ 28,496
ELS/BOC 123 866 (264) 1,789
Publishing 755 (103) 563 433
Franchising 124 83 86 44
Cross Cultural 85 119 238 290
Language Service overhead expenses and (5,424) (4,620) (10,560) (9,332)
other
--------- --------- --------- ---------
Total Language Services 10,440 12,176 16,721 21,720
Berlitz GlobalNET 1,644 1,793 2,289 2,778
General corporate HQ expenses (3,530) (3,371) (6,842) (6,311)
--------- --------- --------- ---------
Total EBITA 8,554 10,598 12,168 18,187
--------- --------- --------- ---------
Amortization of publishing rights, excess of
cost over net assets acquired, and other
intangibles:
Language Services:
Instruction (2,525) (2,528) (5,070) (5,072)
ELS/BOC (1,348) (1,336) (2,695) (2,696)
Publishing (99) (100) (199) (200)
Cross Cultural (2) (3) (5) (6)
--------- --------- --------- ---------
Total Language Services (3,974) (3,967) (7,969) (7,974)
Berlitz GlobalNET (395) (309) (753) (641)
--------- --------- --------- ---------
Total intangible amortization (4,369) (4,276) (8,722) (8,615)
--------- --------- --------- ---------
Total operating profit 4,185 6,322 3,446 9,572
Interest expense on long-term debt (20) (2,768) (1,873) (5,617)
Interest expense on Convertible Debentures (2,004) -- (2,435) --
Interest expense to affiliates (648) (549) (1,236) (1,091)
Other income (expense), net (80) (789) 885 (351)
--------- --------- --------- ---------
Total consolidated income (loss) before taxes,
minority interest, and extraordinary item $ 1,433 $ 2,216 $ (1,213) $ 2,513
========= ========= ========= =========
</TABLE>
14
<PAGE>
Assets: December 31,
June 30, 1999 1998
--------- ---------
Language Services:
Instruction $ 424,281 $ 426,641
ELS/BOC 106,086 111,980
Publishing 25,771 23,982
Franchising 6,785 6,640
Other 1,296 427
--------- ---------
Total Language Services 564,219 569,670
Berlitz GlobalNET 96,040 84,794
General corporate 15,306 13,495
Eliminations of intersegment receivables (4,958) (4,498)
--------- ---------
Total consolidated assets $ 670,607 $ 663,461
========= =========
<TABLE>
<CAPTION>
Three Months ended June 30, Six Months ended June 30,
--------------------------- -------------------------
1999 1998 1999 1998
------- ------- ------- -------
<S> <C> <C> <C> <C>
Depreciation:
Language Services:
Instruction $ 1,297 $ 1,164 $ 2,452 $ 2,290
ELS/BOC 209 226 490 457
Publishing 417 279 841 493
Franchising 6 5 10 15
Language Service overhead and 121 126 237 223
other
------- ------- ------- -------
Total Language Services 2,050 1,800 4,030 3,478
Berlitz GlobalNET 474 513 1,041 1,027
General corporate 122 140 293 264
------- ------- ------- -------
Total consolidated depreciation $ 2,646 $ 2,453 $ 5,364 $ 4,769
======= ======= ======= =======
Capital expenditures:
Language Services:
Instruction $ 3,754 $ 3,039 $ 7,051 $ 5,628
ELS/BOC 197 99 577 285
Publishing 881 910 1,370 1,501
Franchising 25 -- 30 --
------- ------- ------- -------
Total Language Services 4,857 4,048 9,028 7,414
Berlitz GlobalNET 475 466 666 772
General corporate 522 121 871 320
------- ------- ------- -------
Total consolidated capital
expenditures $ 5,854 $ 4,635 $10,565 $ 8,506
======= ======= ======= =======
</TABLE>
The following tables present certain information about the geographic areas
in which the Company operates:
<TABLE>
<CAPTION>
Three Months ended June 30, Six Months ended June 30,
--------------------------- -------------------------
1999 1998 1999 1998
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Revenues from external customers:
United States $ 37,430 $ 40,087 $ 71,750 $ 78,261
Japan 17,064 14,763 32,877 29,191
Germany 10,801 10,194 21,904 20,126
Ireland 6,621 7,034 13,020 15,048
France 5,923 4,345 11,369 8,531
Brazil 3,955 5,820 6,865 10,734
Other foreign countries 29,388 25,266 57,759 50,274
-------- -------- -------- --------
Total $111,182 $107,509 $215,544 $212,165
======== ======== ======== ========
</TABLE>
15
<PAGE>
<TABLE>
<CAPTION>
Three Months ended June 30, Six Months ended June 30,
1999 1998 1999 1998
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Operating (loss) profit:
EBITA :
United States $ 3,802 $ 4,173 $ 5,133 $ 7,363
Japan 1,309 2,055 1,850 3,014
Germany 1,197 1,320 2,454 2,656
Ireland 284 583 277 1,031
France 648 157 1,047 410
Brazil 617 1,066 903 1,606
Other foreign countries 5,451 5,654 9,610 10,194
General corporate expenses (4,754) (4,410) (9,106) (8,087)
--------- --------- --------- ---------
Total EBITA 8,554 10,598 12,168 18,187
--------- --------- --------- ---------
Amortization of publishing rights,
excess of cost over net assets
acquired, and other intangibles:
United States (3,664) (3,569) (7,287) (7,163)
Japan (326) (288) (660) (594)
Germany (63) (64) (129) (128)
Ireland (11) (12) (24) (48)
France (71) (38) (146) (76)
Brazil (16) (16) (32) (32)
Other foreign countries (218) (289) (444) (574)
--------- --------- --------- ---------
Total intangible amortization (4,369) (4,276) (8,722) (8,615)
--------- --------- --------- ---------
Intercompany royalties:
United States 3,995 4,470 7,583 7,769
Japan (956) (1,485) (1,522) (1,965)
Germany (400) (373) (815) (749)
Ireland (289) (333) (525) (678)
France (224) (242) (531) (493)
Other foreign countries (2,126) (2,037) (4,190) (3,884)
--------- --------- --------- ---------
Total intercompany royalties -- -- -- --
--------- --------- --------- ---------
Total operating profit $ 4,185 $ 6,322 $ 3,446 $ 9,572
========= ========= ========= =========
</TABLE>
<TABLE>
<CAPTION>
Long lived assets: Property &
Equipment Other Intangible
net Assets* Assets Total
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
June 30, 1999:
United States $ 10,205 $ 7,747 $ 405,377 $ 423,329
Japan 8,122 38 45,438 53,598
Germany 3,065 -- 8,416 11,481
France 1,783 -- 6,230 8,013
Brazil 3,009 -- 2,113 5,122
Ireland 1,076 5 1,569 2,650
Other foreign countries 11,459 362 28,376 40,197
General corporate 5,161 3,966 1,596 10,723
========= ========= ========= =========
Total $ 43,880 $ 12,118 $ 499,115 $ 555,113
========= ========= ========= =========
December 31, 1998:
United States $ 8,414 $ 7,335 $ 402,507 $ 418,256
Japan 8,685 97 49,165 57,947
Germany 3,008 -- 9,443 12,451
France 1,783 -- 7,192 8,975
Brazil 3,250 -- 2,145 5,395
Ireland 1,562 151 1,793 3,506
Other foreign countries 10,533 192 29,173 39,898
General corporate 3,909 2,557 1,596 8,062
========= ========= ========= =========
Total $ 41,144 $ 10,332 $ 503,014 $ 554,490
========= ========= ========= =========
</TABLE>
*Excludes financial instruments and deferred tax assets.
16
<PAGE>
BERLITZ INTERNATIONAL, INC.
PART I. FINANCIAL INFORMATION
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read in conjunction with the accompanying
Consolidated Financial Statements and notes thereto and with the Company's
audited Consolidated Financial Statements and notes thereto for the fiscal year
ended December 31, 1998. Certain statements contained within this discussion
constitute forward-looking statements. See "Special Note Regarding Forward
Looking Statements."
As of January 1, 1999, the Company reorganized into two separate autonomous
business segments: (i) Language Services, including Language Instruction,
Publishing, Franchising, Cross Cultural and ELS/BOC (i.e., ELS Educational
Services, Inc. ("ELS") and Berlitz on Campus ("BOC"), both of which provide
intensive English programs); and (ii) Berlitz GlobalNET (formerly Translation
Services). Language Services is organized geographically into four operating
divisions (North America, Asia, Latin America and Europe) while Berlitz
GlobalNET is consolidated into three geographic divisions: the Americas (North
and Latin Americas), Asia and Europe. The lines-of- business orientation is
expected to increase operational efficiency on a global basis.
Results of Operations - Quarter Ended June 30, 1999 vs. June 30, 1998
Sales for the quarter ended June 30, 1999 were $111.2 million, 3.4% above the
prior year. This rise was primarily due to increases in operating activity for
Language Instruction and Berlitz GlobalNET, partially offset by reduced
intensive English program revenues and unfavorable exchange rate fluctuations.
Excluding the effects of unfavorable exchange rate fluctuations of $2.6 million,
sales increased from the prior year by 5.9%. The following table compares
revenues by business segment for the second quarter.
Business Segment Revenues: (Dollars in millions)
- --------------------------------------------------------------------------------
June 30, Growth (Decline) from Prior Year
--------------- ------------------------------------
1999 1998 Exchange(2) Operations(1) Total
------ ------ ----------- ------------- ------
Language Services:
Instruction $ 69.9 $ 68.6 $ (2.2) $ 3.5 $ 1.3
ELS/BOC 12.4 14.0 -- (1.6) (1.6)
Publishing 4.1 3.4 -- 0.7 0.7
Franchising 0.6 0.6 -- -- --
Other 0.5 0.3 -- 0.2 0.2
------ ------ ------ ------ ------
Total Language Services 87.5 86.9 (2.2) 2.8 0.6
Berlitz GlobalNET 23.7 20.6 (0.4) 3.5 3.1
------ ------ ------ ------ ------
Total $111.2 $107.5 $ (2.6) $ 6.3 $ 3.7
====== ====== ====== ====== ======
- ----------------------------------
(1) Adjusted to eliminate fluctuations in foreign currency from year-to-year by
assuming a constant exchange rate over two years, using as the base the
first year of the periods being presented.
(2) The unfavorable exchange rate fluctuations ($2.6 million) primarily resulted
from a strengthened dollar against the Latin American currencies (most
significantly the Brazilian real) and all European currencies, offset by a
weaker dollar against the Japanese yen.
17
<PAGE>
Within Language Services, Language Instruction sales for the 1999 second quarter
rose 1.9% from the prior year, and excluding unfavorable exchange rate
fluctuations, were 5.1% higher than in 1998. This improvement was primarily due
to average revenue per lesson ("ARPL") increases in most countries. Total lesson
volume increased 1.9% from the prior year, primarily as strength in Europe and
Latin America was offset by weakness in North America and Asia. Geographically,
Language Instruction revenue and lesson volume was dispersed as follows:
Language Instruction Revenue: (Dollars in millions)
- ---------------------------------------------------------------------
June 30, Growth (Decline) from Prior Year
------------- -----------------------------------
1999 1998 Exchange Operations Total
----- ----- -------- ---------- -----
North America $12.4 $13.3 $ -- $(0.9) $(0.9)(1)
Asia 16.4 15.1 1.8 (0.5) 1.3(2)
Latin America 12.9 14.3 (2.8) 1.4 (1.4)(3)
Europe 28.2 25.9 (1.2) 3.5 2.3(4)
----- ----- ----- ----- -----
Total revenue $69.9 $68.6 $(2.2) $ 3.5 $ 1.3
===== ===== ===== ===== =====
- -------------------------------------
(1) Decline is due to lesson volume shortfalls in the USA.
(2) Primarily reflects the effect of a weaker US dollar against the Japanese
yen, which was partially offset by reduced lesson volume in Japan due to the
continued poor local economic conditions.
(3) Primarily reflects the effect of a stronger dollar against the Brazilian
real, partially offset by volume and ARPL increases, primarily in Mexico.
(4) Primarily reflect improved volume and ARPL in most countries (in particular
Belgium, France, Germany, Israel, Poland, and Spain), partly offset by a
strengthened dollar against all European currencies.
<TABLE>
<CAPTION>
Language Instruction Lesson Volume: (Lessons in thousands)
- --------------------------------------------------------------------------------------
June 30, Growth (Decline) from Prior Year
----------------- --------------------------------
Number of
1999 1998 lessons Percentage
------- ------- ------- -----------
<S> <C> <C> <C> <C>
North America 288.3 304.6 (16.3) (5.4)%(1)
Asia 256.4 269.8 (13.4) (5.0)%(2)
Latin America 366.5 349.5 17.0 4.9%(3)
Europe 642.9 601.5 41.4 6.9%(4)
======= ======= ======= =======
Total lesson volume 1,554.1 1,525.4 28.7 1.9%
======= ======= ======= =======
</TABLE>
- -------------------------------------
(1) North America's volume decline primarily reflects reduced institutional
training volume due to mergers and acquisitions in the petroleum and
financial service sectors, as well as reduced lesson demand due to
downsizing, decrease in expatriations, and the freezing of training budgets.
(2) Asia's volume has decreased due to the continued economic recession in Japan
and Hong Kong.
(Footnotes are continued on next page)
18
<PAGE>
(3) Lesson volume increased in Latin America primarily due to strong sales in
Mexico, as well as the opening of five new language centers in the first
half of 1999. Lesson volume was down in Venezuela and Argentina due to
current economic recessions in these countries.
(4) Europe's volume improvement reflects continued demand for Berlitz services,
with the largest increases generated by Germany, France, Israel, Spain,
Poland, Italy and Belgium. Both Poland and Israel had new school openings
during the first half of 1999, which contributed to the improved volume.
For the second quarter of 1999, ARPL was $39.88, as compared to $40.25 in the
comparable prior-year period. The decrease reflected the unfavorable impact of
exchange rate fluctuations of ($1.40); excluding the effects of the exchange,
ARPL increased over prior year by $1.03. ARPL ranged from a high of
approximately $59.50 in Japan to a low of $15.36 in Thailand, reflecting effects
of foreign exchange rates and differences in the economic value of the service.
Within Language Services, ELS/BOC revenues for the second quarter declined 11.1%
from the prior year. ELS/BOC continued to be affected by weakened Asian student
enrollments due to the economic conditions in the Far East. Enrollments from
Latin America are also down due to the economic instability in Venezuela and
Brazil, and the increased strength of the dollar over the currencies in these
countries. More aggressive pricing and agent commission structures by
competitors, and a market trend toward less intensive schedules has also
adversely affected results. ELS/BOC has taken actions to address these problems,
including filling vacant sales positions and articulating its new business plan
to its agents, and monitoring overhead expenses. ELS/BOC also expects to
intensify its recruitment activities, introduce an enhanced website, build
strong brand recognition through completion of various marketing projects, and
increase training and motivation of its key representatives.
Publishing revenues increased 21.9% over prior year, due to increased licensing
royalty revenue, and increased sales in North America due to a 1999 warehouse
club promotion. Franchising revenues were slightly lower than prior year. The
Company opened one Berlitz Franchise in Mexico in the second quarter of 1999.
Berlitz GlobalNET sales, excluding the effects of exchange rate fluctuations,
rose 16.9% from 1998. Geographically, sales are above prior year in all regions.
The following table compares Berlitz GlobalNET revenues by region for the second
quarter:
19
<PAGE>
<TABLE>
<CAPTION>
Berlitz GlobalNET Revenue: (Dollars in millions)
-------------------------- ---------------------------------------------------------
June 30, Growth (Decline) from Prior Year
-------------- ------------------------------------
1999 1998 Exchange Operations Total
----- ----- -------- ---------- -----
<S> <C> <C> <C> <C> <C>
America $11.6 $ 9.2 $ -- $ 2.4 $ 2.4(1)
Asia 1.2 1.0 0.1 0.1 0.2
Europe 12.3 11.0 (0.5) 1.8 1.3(2)
Inter-company eliminations (1.4) (0.6) -- (0.8) (0.8)
===== ===== ===== ===== =====
Total revenue $23.7 $20.6 $(0.4) $ 3.5 $ 3.1
===== ===== ===== ===== =====
</TABLE>
(1) North America had a strong quarter, due in part to large projects from
the automotive industry during this period, and continued growth in the
interpretation service business.
(2) The sales increase in Europe is attributable to volume increases in
Norway and Denmark, and sales from acquisitions made in France and
Poland in the second and fourth quarters of 1998, respectively. These
increases were partially offset by sales decline in Ireland, due in part
to the delay of major projects by a certain client.
The total Company's cost of services and products sold as a percentage of sales
was 59.4% in the 1999 second quarter, compared to 58.7% in the same prior year
period. The higher percentage is mainly attributable to higher teacher costs,
lower GlobalNET production margins, and an increase in the provision for
doubtful accounts over prior year. Selling, general and administrative expenses
as a percentage of sales were 32.9% in the 1999 second quarter, compared with
31.4% in the comparable prior year period. The increase is due to higher
administrative salaries and related costs, and higher advertising costs.
The Company's total EBITA* for the 1999 second quarter was $8.6 million, or 7.7%
of sales, compared to $10.6 million, or 9.9% of sales, in the same prior year
period. The following table displays the comparative second quarter EBITA by
business segment:
Business Segment EBITA: (Dollars in millions)
- ----------------------- -------------------------------------------------------
June 30, Growth (Decline) from Prior Year
---------------- ----------------------------------
1999 1998 Exchange Operations Total
----- ----- -------- ---------- -----
Language Services:
Instruction $14.8 $15.8 $(0.7) $(0.3)(2) $(1.0)
ELS/BOC 0.1 0.9 -- (0.8)(3) (0.8)
Publishing 0.8 (0.1) -- 0.9(4) 0.9
Franchising 0.1 0.1 -- -- --
Overhead & Other (5.4) (4.5) 0.1 (1.0)(5) (0.9)
----- ----- ----- ----- -----
Total Language Services 10.4 12.2 (0.6) (1.2) (1.8)
Berlitz GlobalNET 1.7 1.8 -- (0.1)(6) (0.1)
Corporate and other (3.5) (3.4) -- (0.1)(7) (0.1)
----- ----- ----- ----- -----
Total $ 8.6 $10.6 $(0.6)(1) $(1.4) $(2.0)
===== ===== ===== ===== =====
(Footnotes are continued on next page)
20
<PAGE>
EBITA Margin %: June 30,
--------------- --------------------------
1999 1998
----------- -----------
Language Services:
Instruction (8) 21.2% 23.1%
ELS/BOC (3) 1.0% 6.2%
Publishing (4) 18.3% (3.0)%
Franchising 20.9% 13.2%
Total Language Services 11.9% 14.0%
Berlitz GlobalNET (9) 6.9% 8.7%
Total 7.7% 9.9%
--------------------------
(1) The net unfavorable foreign exchange impact is mainly attributable to
the Latin American countries.
(2) The decline in Instruction operating EBITA is due mainly to the North
American region and Asia. In North America, the combined effect of
decreased volume and increases in teacher salaries and rent expense led
to the decline over prior year. The decline in Asia is primarily due to
decreased volume and increases in advertising costs and salary
expenses. The decreases in these countries were partially offset by
exceptional EBITA increases in Mexico, and profitable results generated
by the European countries, notably; Denmark and France.
(3) Despite reductions in its overall costs from the prior year, ELS/BOC's
EBITA and EBITA margin has decreased because the cost cutting has not
been enough to cover the shortfalls in sales. In addition, an ELS joint
venture in Japan consummated in October 1998 generated an EBITA loss of
$0.2 million in the second quarter of 1999 due to its start-up nature.
(4) The increased sales over prior year in Publishing combined with
decreases in advertising costs, and other sundry expenses led to a
profit for the quarter, compared to a loss in the prior year.
(5) Language Service's overhead costs increased over the prior year due to
increases in fixed employee costs, advertising, and travel expenses.
(6) The decline in EBITA for Berlitz GlobalNET is due to decreases in
Europe, primarily Ireland and Germany due largely to temporary lower
sales volume, and Norway and Denmark due to low margin projects. These
declines are partially offset by activity in France and Poland from
acquisitions made in the second and fourth quarters of 1998,
respectively. In the Americas, EBITA increased $0.2 million due to
improved margins.
(7) Corporate expenses rose due to increases in salary-related costs.
(8) The reduction in Instruction's 1999 EBITA margin occurred primarily as
teacher costs, rent, and advertising expenses grew faster than
revenues.
(9) GlobalNET's EBITA margin decreased due to low translation production
margins in Europe, and income of $0.2 million being reported in
provision for doubtful accounts in the second quarter of the prior
year.
- --------------------------------------------------------------------------------
*EBITA as used herein is defined as sales less cost of services and products
sold, and selling, general and administrative expenses. It is calculated using
amounts determined in accordance with U.S. generally accepted accounting
principles ("U.S. GAAP"). EBITA is not a defined term under U.S. GAAP and is not
indicative of operating income or cash flows from operations as determined under
U.S. GAAP.
21
<PAGE>
Interest expense on long-term debt for the three months ended June 30, 1999
decreased $2.7 million from the comparable prior year period, due to the
extinguishment of debt in mid-March 1999. Interest expense on the new
Convertible Debentures was $2.0 million for the second quarter of 1999. Other
expense, net for the three months ended June 30, 1999 decreased by $0.7 million
over the prior year, primarily due to foreign exchange gains.
The Company recorded second quarter income tax expenses of $1.8 and $1.5 million
for 1999 and 1998, respectively. The effective tax rates in both 1999 and 1998
were above the U.S. Federal statutory tax rate primarily as a result of
nondeductible amortization charges.
Results of Operations - Six Months Ended June 30, 1999 vs. June 30, 1998
Sales for the six months ended June 30, 1999 were $215.5 million, 1.6% above the
prior year. The sales growth is primarily due to activity generated from the
Language Instruction and Berlitz GlobalNET business segments, which is partially
offset by reduced sales volume from ELS/BOC programs, and unfavorable foreign
exchange rate fluctuations. Excluding the effects of unfavorable exchange rate
fluctuations of $3.4 million, sales increased from the prior year by 3.2%. The
following table compares revenues by business segment for the first half of the
year.
Business Segment Revenues: (Dollars in millions)
- -------------------------- --------------------------------------------------
June 30, Growth (Decline) from Prior Year
--------------- ---------------------------------
1999 1998 Exchange(2) Operations(1) Total
------ ------ ----------- ------------- -----
Language Services:
Instruction $136.3 $133.7 $ (3.1) $ 5.7 $ 2.6
ELS/BOC 24.9 29.0 -- (4.1) (4.1)
Publishing 7.2 7.0 -- 0.2 0.2
Franchising 0.9 0.9 (0.1) 0.1 --
Other 0.9 0.9 -- -- --
------ ------ ------ ------ -----
Total Language Services 170.2 171.5 (3.2) 1.9 (1.3)
Berlitz GlobalNET 45.3 40.7 (0.2) 4.8 4.6
====== ====== ====== ====== =====
Total $215.5 $212.2 $ (3.4) $ 6.7 $ 3.3
====== ====== ====== ====== =====
- ----------------------------------
(1) Adjusted to eliminate fluctuations in foreign currency from year-to-year by
assuming a constant exchange rate over two years, using as the base the
first year of the periods being presented.
(2) The unfavorable exchange rate fluctuations ($3.4 million) primarily resulted
from a strengthened dollar against the Latin American currencies (most
significantly the Brazilian real), offset by a weaker dollar against the
Japanese yen.
22
<PAGE>
Within Language Services, Language Instruction sales for the 1999 first half
rose 1.9% from the prior year, and excluding unfavorable exchange rate
fluctuations, were 4.3% higher than in 1998. This improvement was primarily due
to ARPL increases in most countries. Total lesson volume increased 1.1% from the
prior year, primarily as strength in Europe and Mexico was offset by weakness in
Asia and the USA. Geographically, Language Instruction revenue and lesson volume
was dispersed as follows:
23
<PAGE>
<TABLE>
<CAPTION>
Language Instruction Revenue: (Dollars in millions)
- ----------------------------- --------------------------------------------------
June 30, Growth (Decline) from Prior Year
--------------- --------------------------------
1999 1998 Exchange Operations Total
------ ------ -------- ---------- ----------
<S> <C> <C> <C> <C> <C>
North America $ 24.2 $ 24.9 $ (0.1) $ (0.6) $ (0.7)(1)
Asia 32.0 29.9 3.0 (0.9) 2.1(2)
Latin America 23.1 26.5 (5.5) 2.1 (3.4)(3)
Europe 57.0 52.4 (0.5) 5.1 4.6(4)
====== ====== ====== ====== ======
Total revenue $136.3 $133.7 $ (3.1) $ 5.7 $ 2.6
====== ====== ====== ====== ======
</TABLE>
- -------------------------------------
(1) Decline is due to lesson volume shortfalls in the USA.
(2) Primarily reflects the effect of a weaker US dollar against the Japanese
yen, which was partially offset by reduced lesson volume in Japan due to the
continued poor local economic conditions.
(3) Primarily reflects the effect of a stronger dollar against all Latin America
currencies, notably the Brazilian real and Mexican peso, partially offset by
volume increases in Mexico and Peru and ARPL increases in Mexico.
(4) Primarily reflect improved volume and ARPL in most countries (in particular
Belgium, France, Germany, Israel, Poland, and Spain), as well as unfavorable
exchange rate fluctuations in Israel and Poland.
<TABLE>
<CAPTION>
Language Instruction Lesson Volume: (Lessons in thousands)
- ----------------------------------- --------------------------------------------------
June 30, Growth (Decline) from Prior Year
---------------- --------------------------------
Number of
1999 1998 lessons Percentage
------- ------- --------- ----------
<S> <C> <C> <C> <C>
North America 567.2 587.4 (20.2) (3.4)%(1)
Asia 500.3 524.6 (24.3) (4.6)%(2)
Latin America 656.5 637.9 18.6 2.9%(3)
Europe 1,288.3 1,229.4 58.9 4.8%(4)
------- ------- ----- ----
Total lesson volume 3,012.3 2,979.3 33.0 1.1%
======= ======= ===== ====
</TABLE>
- -------------------------------------
(1) North America's volume decline primarily reflects reduced institutional
training volume due to mergers and acquisitions in the petroleum and
financial service sectors, as well as reduced lesson demand due to
downsizing, decrease in expatriations, and the freezing of training budgets
by these companies.
(2) Asia's volume has decreased due to the continued economic recession in Japan
and Hong Kong.
(3) Lesson volume increased in Latin America primarily due to strong sales in
Mexico, and the opening of five new language centers in the first half of
1999 in the Latin America region. Lesson volume is down in Venezuela and
Argentina due to current economic recessions in these countries.
(4) Europe's volume improvement reflects continued growth in the region, with
the largest increases generated by Germany, Israel, France, Poland, Spain
and Italy. Both Israel and Poland had new school openings during the first
half of 1999, which contributed to the improved volume.
24
<PAGE>
For the first half of 1999, ARPL was $40.42, as compared to $40.37 in the
comparable prior-year period. The increase reflected the favorable impact of
product mix and price increases (i.e.,$1.07), partly offset by the effects of
unfavorable exchange rate fluctuations ($1.02). ARPL ranged from a high of
approximately $59.74 in Japan to a low of $15.38 in Thailand, reflecting effects
of foreign exchange rates and differences in the economic value of the service.
Within Language Services, ELS/BOC revenues declined 14.3% from the prior year.
ELS/BOC continued to be affected by weakened Asian student enrollments due to
the economic conditions in the Far East. Enrollments from Latin America are also
down due to the economic instability in Venezuela and Brazil, and the increased
strength of the dollar over the currencies in these countries. More aggressive
pricing and agent commission structures by competitors has also adversely
affected results. In addition, due to organization changes and the relocation of
the ELS headquarters from Los Angeles to Princeton in the latter part of 1998,
many overseas sales agents did not sell the ELS programs as aggressively in the
latter months of 1998 and early part of 1999 due to perceived uncertainties with
the future of ELS programs. This has impacted student arrivals during the first
and second quarter of 1999. ELS/BOC has taken actions to address these problems,
including filling vacant sales positions and articulating its new business plan
to its agents, and monitoring overhead expenses. ELS/BOC also expects to
intensify its recruitment activities, introduce an enhanced web-site, build
strong brand recognition through completion of various marketing projects, and
increase training and motivation of its key representatives.
Publishing revenues increased 3.7% over prior year, due to increased licensing
royalty revenue. Franchising revenues remained flat with the prior year. The
Company opened five ELS franchises in the first quarter of 1999, four of which
are located in Taiwan, and the other in Indonesia. Berlitz Franchising opened
one franchise in Mexico during the second quarter of 1999.
Berlitz GlobalNET sales, excluding the unfavorable effects of exchange rate
fluctuations, rose 11.6% from 1998. Geographically, sales are above prior year
in all regions. The following table compares Berlitz GlobalNET revenues by
region for the first half:
Berlitz GlobalNET Revenue: (Dollars in millions)
- -------------------------- --------------------------------------------------
June 30, Growth (Decline) from Prior Year
-------------- ---------------------------------
1999 1998 Exchange Operations Total
----- ----- -------- ---------- -----
America $20.4 $18.0 $(0.1) $ 2.5 $ 2.4(1)
Asia 2.4 2.0 0.2 0.2 0.4
Europe 24.6 22.5 (0.2) 2.3 2.1(2)
Inter-company eliminations (2.1) (1.8) (0.1) (0.2) (0.3)
----- ----- ----- ----- -----
Total revenue $45.3 $40.7 $(0.2) $ 4.8 $ 4.6
===== ===== ===== ===== =====
(1) Sales are higher than prior year in the North America due partly to
large projects from the automotive industry during the second quarter of
1999, and continued strength in traditional business.
(2) The sales increase in Europe is attributable to volume increases in
Norway and Denmark, and sales from acquisitions made in France and
Poland in the second and fourth quarters of 1998, respectively. These
increases were partially offset by sales decline in Ireland, due in part
to a temporary delay of major projects by a certain client.
25
<PAGE>
The total Company's cost of services and products sold as a percentage of sales
was 60.7% in the 1999 first half, compared to 59.6% in the same prior year
period. The higher percentage is mainly attributable to higher teacher salaries,
a slight decline in GlobalNET production margins, and rent expense. Selling,
general and administrative expenses as a percentage of sales were 33.7% in the
first six months of 1999, compared with 31.9% in the comparable prior year
period. The increase is due to higher administrative salaries, advertising and
rent expense.
The total Company's EBITA for the 1999 first half was $12.2 million, or 5.6% of
sales, compared to $18.2 million, or 8.6% of sales, in the same prior year
period. The following table displays the comparative EBITA for the first half of
the year by business segment:
Business Segment EBITA: (Dollars in millions)
- ----------------------- --------------------------------------------------
June 30, Growth (Decline) from Prior Year
-------------- --------------------------------
1999 1998 Exchange Operations Total
----- ----- -------- ---------- -----
Language Services:
Instruction $26.7 $28.5 $(1.2) $(0.6)(2) $(1.8)
ELS/BOC (0.3) 1.8 -- (2.1)(3) (2.1)
Publishing 0.6 0.4 -- 0.2(4) 0.2
Franchising 0.1 -- -- 0.1 0.1
Overhead & Other (10.4) (9.0) 0.2 (1.6)(5) (1.4)
----- ----- ----- ----- -----
Total Language Services 16.7 21.7 (1.0) (4.0) (5.0)
Berlitz GlobalNET 2.3 2.8 (0.1) (0.4)(6) (0.5)
Corporate and other (6.8) (6.3) -- (0.5)(7) (0.5)
----- ----- ----- ----- -----
Total $12.2 $18.2 $(1.1)(1) $(4.9) $(6.0)
===== ===== ===== ===== =====
EBITA Margin %: June 30,
--------------------------
1999 1998
----------- -----------
Language Services:
Instruction (8) 19.6% 21.3%
ELS/BOC (3) (1.1)% 6.2%
Publishing 7.8% 6.2%
Franchising 9.1% 4.6%
Total Language Services 9.8% 12.7%
Berlitz GlobalNET (9) 5.1% 6.8%
Total 5.6% 8.6%
--------------------------------
(1) The net unfavorable foreign exchange impact is attributable mainly to
the Latin American countries.
(2) The decline in Instruction operating EBITA is due mainly to the U.S.
and Japan. In the U.S., the growth in rent and certain other fixed
costs outpaced the growth in sales. The decline in Japan primarily is
due to increases in teacher salaries, salary expenses, and rent. The
decreases in these countries were partially offset by EBITA increases
in Mexico, Peru, and the profitable results generated by the European
countries, notably; France, Denmark, Belgium and Austria.
(Footnotes are continued on next page)
26
<PAGE>
(3) Despite reductions in its overall costs from the prior year, ELS/BOC's
EBITA and EBITA margin has decreased because the percentage decline in
ELS' revenues outpaced the percentage decline of certain costs (most
notably teachers' salaries, commissions and rent expense). In addition,
an ELS joint venture in Japan consummated in October 1998 generated an
EBITA loss of $0.5 million in the first half of 1999 due to its
start-up nature.
(4) The increase in Publishing EBITA is due to the combined effects of the
increase in sales and the decrease in operating expenses.
(5) Language Service's overhead cost increase over prior year is
attributable to fixed employee costs, advertising and travel expenses.
(6) The decline in EBITA for Berlitz GlobalNET is due to decreases in
Europe and Asia, primarily Ireland and Germany, due in part to lower
sales volume. These declines are is partially offset by increased
activity in France and Poland from acquisitions made in the second and
fourth quarters of 1998, respectively. In the Americas, EBITA increased
$0.4 million over prior year due to stronger sales and improved
margins.
(7) Corporate expenses rose due to increases in salary-related costs, and
other sundry expenses.
(8) The reduction in Instruction's 1999's EBITA Margin occurred primarily
as teacher costs, rent and salary related costs grew faster than
revenues.
(9) GlobalNET's EBITA margin decreased due to lower margins in certain
European countries, and increases in administrative positions and rent
expense.
Interest expense on long-term debt for the six months ended June 30, 1999
decreased $3.7 million from the comparable prior year period, due to the
extinguishment of debt in mid-March 1999. Interest expense on the new
Convertible Debentures was $2.4 million for the first half of 1999. Other
income, net for the six months ended June 30, 1999 increased by $1.2 million
over the prior year, primarily due to foreign exchange gains.
The Company recorded income tax expenses of $2.0 million and $1.7 million in
first six months of 1999 and 1998, repectively. The effective tax rates in both
1999 and 1998 were above the U.S. Federal statutory tax rate primarily as a
result of nondeductible amortization charges.
27
<PAGE>
On March 11, 1999, in connection with the issuance of the Convertible Debentures
and an affiliate note, the Company extinguished the long-term debt under its
1997 credit agreement (the "Bank Facility"). The Company also terminated its
interest rate swap agreement, which hedged the floating rate Bank Facility, for
a cash payment of approximately $1.1 million. Consequently, in the first half of
1999, the Company has recorded an extraordinary loss, net of tax benefit, of
approximately $2.1 million, consisting of the interest rate swap's fair market
value and existing unamortized deferred finance costs at the time of
extinguishment of the underlying debt.
Financial Condition
Historically, the primary source of the Company's liquidity has been the cash
provided by operations; capital expenditures, working capital requirements and
acquisitions (except ELS) generally have been funded from internally generated
cash. Although each geographic area exhibits different patterns of lesson volume
over the course of the year, the Company's sales are generally not seasonal in
the aggregate.
Net cash used in operating activities was $6.4 million for the six months ended
June 30, 1999, compared with net cash provided of $19.7 million in the
comparable prior period. This decline of $13.3 million primarily resulted from:
(i) an increase in accounts receivable; (ii) a reduced EBITA; (iii) the payment
of year-end bonus, long-term incentive plan, and non-recurring ELS vacation/sick
pay accruals; and (iv) a payment to terminate the Company's interest rate swap.
Net cash used in investing activities totaled $18.9 million for the six months
ended June 30, 1999, up $7.1 million from the comparable prior year period. This
increase is primarily due to an acquisition of a translation services business
in the second quarter of 1999. In addition, capital expenditures for the first
half of 1999 increased $2.1 million over the prior year.
Net cash provided by financing activities for the six months ended June 30, 1999
was $17.0 million, $21.6 million higher than in the prior year. This change
primarily reflected the excess of the (i) net proceeds from the issuance of
convertible debentures and notes payable to an affiliate over (ii) the related
extinguished debt.
Other items impacting the Company's liquidity and capital resources are as
follows:
o Reported within accrued expenses at June 30, 1999 were $1.4 million related
to the ELS acquisition.
o On July 1, 1999, Berlitz entered into a license agreement (the "Agreement")
with Children's Television Workshop ("CTW"). Pursuant to this license
agreement, CTW has agreed to create and produce, at its expense, a
television series, entitled "Sesame English", which will initially consist
of 52 15-minute episodes which will be complemented by instruction
curricula and materials developed by Berlitz. In addition, Berlitz was
granted certain rights by CTW, including the exclusive right to use certain
Sesame Street and Sesame English names, logos and characters in connection
with language instructional products, services and schools.
28
<PAGE>
The Agreement, covering an initial term of five years, provides for
payments to CTW of $4 million at inception and an aggregate of $6 million
in minimum guaranteed royalties paid in installments over the initial term
of the agreement. In the event that Berlitz enters into any sublicenses or
other third-party arrangements with a sublicensee for language instruction
services in Japan, such minimum guaranteed royalties shall be reduced
dollar for dollar, up to a maximum of $2 million from CTW's share of
payments from such Japanese sublicensees. If certain conditions are met,
Berlitz may extend the Agreement for another five years in exchange for
annual minimum guaranteed royalties equal to the greater of $2 million, or
an amount equal to 80% of the royalties earned by CTW under the Agreement
during the fifth year of the initial term.
o As part of its CTW and general marketing efforts, Berlitz is in the process
of pursuing opportunities to expand the use of the Internet for the
marketing and distribution of its products and services.
o In June 1999, the Company acquired certain assets, operating subsidiaries
and key personnel of Language Management International, Inc., a
translations services company. The purchase price was $7.8 million, plus a
contingent payment based on gross revenues for the twelve months ending
June 30, 2000. The Company also incurred various transaction-related
expenditures and accrued expenses. At June 30, 1999, in connection with
this acquisition, the Company recorded $11.8 million of goodwill and $4.0
million of accrued current liabilities for transaction-related expenses and
contingencies.
o On June 8, 1999, the Company's shareholders approved the Company's 1999
Long-Term Executive Incentive Compensation Plan (the "1999 LTIP"). The 1999
LTIP provides for potential cash awards to be paid to senior management in
2002 if certain revenue, earnings and cash flow targets are achieved for
the three year period from 1999 to 2001. The 1999 LTIP is intended to be an
unfunded plan, and the Company is not required to establish any fund or
segregate any assets. Based on limitations contained within the 1999 LTIP,
total awards are currently expected to range from a minimum of $0 to a
maximum of $7.2 million.
o On March 31, 1999, the Company entered into a new $25 million revolving
credit facility (the "Revolving Facility"), which expires in February 2002.
At the option of the Company, outstanding borrowings under the Revolving
Facility bear interest at variable rates equal to either (i) a base rate
approximating the U.S. prime rate or (ii) the rate offered by certain
reference banks to prime banks in the interbank Eurodollar market, fully
adjusted for reserves plus a margin ranging from 0.375% to 0.5%; such
margin is dependent on a specified leverage ratio of the Company. In
addition, a commitment fee ranging from 0.125% to 0.20% will be charged on
the available but unused amounts under the revolving credit facility,
depending on a specified leverage ratio. There were $4.0 million of
outstanding borrowings under the Revolving Facility at June 30, 1999.
o The Company's Supplemental Executive Retirement Plan ("SERP") provides
retirement income / disability retirement benefits, retiree medical
benefits and death benefits to certain designated executives and their
designated beneficiaries. The Company intends to fund the SERP through a
combination of funds generated from operations and life insurance policies
on the participants.
29
<PAGE>
o The Company is party to currency coupon swap agreements with a financial
institution to hedge the Company's net investments in certain foreign
subsidiaries. These agreements require the Company, in exchange for U.S.
dollar receipts, to periodically make foreign currency payments,
denominated in the Japanese yen, the Swiss franc, the British pound, and
the German mark. Credit loss from counterparty nonperformance is not
anticipated. The estimated fair value of these swap agreements at June 30,
1999, representing the amount that could be settled based on estimates
obtained from a dealer, was a net liability of approximately $0.1 million.
o On March 11, 1999, the Company's shareholders approved the issuance of, and
the Company issued, $155 million aggregate principal amount 12-year
convertible debentures (the "Convertible Debentures") in a private
placement, pursuant to definitive investment agreements (the "Investment
Agreements") dated as of October 2, 1998. Such debentures were issued as
follows: a) $100 million aggregate principal amount (the "Apollo
Debentures") to two affiliates of Apollo Management IV, L.P. ("Apollo"), a
private investment firm; and b) $55 million aggregate principal amount (the
"Benesse Debentures") to Benesse Holding International, Inc. ("BHI"), the
Company's majority shareholder. The Convertible Debentures bear interest at
5% per annum, payable semi-annually. Principal amounts outstanding under
such debentures are not due until March 2011, and the Company is not
required to establish a bond sinking fund for repayment of this principal.
The Convertible Debentures are convertible at any time into shares of the
Company's common stock at a conversion price of $33.05 per share, subject
to anti-dilution related adjustments.
In a separate transaction on March 11, 1999, BHI loaned $50 million to the
Company, evidenced by a 12-year fixed rate subordinated promissory note
(the "BHI Note"). Such note bears interest for the first five years at 5.2%
per annum, and, thereafter, at a renegotiated fixed rate approximating
LIBOR plus a margin based on the Company's then existing leverage. Interest
is payable semiannually in cash while principal repayment is deferred until
maturity. In the event of a change in control, the BHI Note provides for
redemption by the Company, at the option of BHI, at price equal to 101% of
the note's principal amount.
The Company used the proceeds from the sale of the Convertible Debentures,
as well as proceeds from the BHI Note issuance, to repay in full all
outstanding indebtedness pursuant to the Bank Facility and existing notes
payable to Benesse, and for general corporate purposes. The Company
incurred approximately $2.8 million in deferred finance costs associated
with the issuance of the Convertible Debentures and BHI Note.
At June 30, 1999, the Company's liquid assets of $28.2 million consisted of cash
and temporary investments. The Company does not currently have any material
commitments for capital expenditures, except as disclosed below under "The Year
2000 Issue". In the future, the Company anticipates capital expenditures to
continue to be in line with recent historical trends due to the refurbishment of
the Company's language centers, the expansion of the Company's GlobalNET
segment, and technological expansion. The Company plans to meet its debt service
requirements and future working capital needs through funds generated from
operations.
30
<PAGE>
The Year 2000 Issue
Introduction
The Year 2000 issue is the result of certain computerized systems' use of a two
rather than four digit year (e.g., 95 vs. 1995). As a result of the ambiguous
century in such systems, the introduction of twenty-first century dates may
cause systems to function abnormally or not at all.
Recognizing the need to ensure operations will not be adversely affected by Year
2000 failures, the Company established a committee to address any possible
exposure. This committee is responsible for carrying out the Company's awareness
program, assessing key financial and operational systems, for assessing external
relationships with customers and vendors, and for developing and implementing
detailed divisional action plans.
The Company has divided the Year 2000 issue into three areas: (i)
Infrastructure; (ii) Internal Use Financial and Operational Software; and (iii)
Key Third Party Customer and Vendor Relationships. For each area, the committee
is responsible for carrying out the following steps: Inventory, Assessment,
Remediation and Testing, and Contingency Plan Development and Implementation.
The infrastructure area contains all hardware, embedded systems, and software,
except financial and operational software. Non-compliant internal use financial
software is currently being replaced in conjunction with the deployment of
PeopleSoft systems. Such PeopleSoft systems are warranted to be Year 2000
compliant and have been successfully tested as such. Key third party
relationships include external interfaces between the Company and its suppliers,
service providers, and customers that are deemed material to the continued
operation of the Company.
State of Readiness
Overall, the Company's Year 2000 project is currently proceeding on schedule and
is expected to be fully completed by September 29, 1999.
As of April 1998, the committee had completed a worldwide systems inventory and
assessment for the infrastructure and internal use financial and operational
systems areas. To minimize complicating factors, the Company chose to replace
rather than upgrade most non-compliant systems without commercially available
remediation paths at the time of assessment. The Company is employing both
internal and external resources in its remediation efforts.
Remediation and testing of systems began in July 1998 and is scheduled to
continue through September 29, 1999. Testing is scheduled to occur in line with
remediation efforts; as systems are upgraded or replaced, compliance testing of
the system will begin. Based on current progress, the Company reasonably expects
that all internal remediation efforts in this area will be completed on or
before the scheduled completion date. Further, the Company believes it is
unlikely that its efforts to remediate non-compliant financial and operational
software would extend beyond the scheduled completion date.
31
<PAGE>
The Company has conducted a formal communications program with all key vendors
and customers to identify and assess their states of readiness. Based on the
results of this process, the committee is assessing the likelihood of a failure
in a third party's own Year 2000 remediation program and the resulting impact to
the Company. Communications with key third parties are continuing to minimize
the exposure to the Company and its ability to conduct normal business. The
Company completed its initial assessment of external vendor relationships in
November 1998.
Due to the fact that many third parties' programs are not yet fully completed,
the Company expects communications to continue through September 1999. Third
parties that do not provide convincing evidence that they will successfully
achieve compliance by September 1999 will be subject to replacement.
Risk
The Company expects to achieve internal compliance and does not believe that any
reasonably likely risk of material failure exists. Based on management estimates
and the uncertainty surrounding the Company's ability to guarantee the
compliance of third parties, the Company expects that the most likely worst case
is that some third parties fail to successfully and completely remediate all
Year 2000 issues. Third party failures could range from the loss of a utility or
service such as electricity or telecommunications to a loss of revenue due to a
customer's inability to conduct normal business based on the failure of the
customer's or vendor's own systems or those of its own critical third party
relationships.
Third parties deemed material to the Company fall primarily into the following
categories: banks, accounting bureaus, telecommunications providers, utilities,
and customers. Although management estimates that it is reasonably likely that
some third parties may experience failures, the Company does not believe that
the aggregate effect of such failures will have a material effect on the
Company's consolidated future results. This estimate is based on the nature of
the Company's services, its widespread geographic dispersion, and the diversity
of its customer base.
Although third party failures are beyond the reasonable control of the Company,
the Company is making every effort to reduce any negative effect by closely
communicating with third parties to follow the progress of their remediation
programs and minimize the risks associated with a third party's failure to
achieve compliance.
Contingency Plans
To further minimize any risk associated with any internal or third party failure
to achieve compliance, the Company is continuing the development of contingency
plans as necessary for those critical systems and third party relationships that
have the potential to materially interrupt the Company's ability to conduct
normal business. Based on management assessments, decisions to implement
contingency plans related to the remediation and deployment of internally
developed software have been effected as necessary. All contingency plans deemed
necessary are expected to be fully implemented by the end of the third quarter
of 1999.
Costs to Address the Year 2000 Issue
The Company currently estimates the cost for Year 2000 compliance with respect
to its information and production systems to be approximately $4.9 million,
consisting of: $3.6
32
<PAGE>
million for replacements of financial accounting and operational systems with
the remainder dedicated to infrastructure and third party relationship
remediation.
Recent Accounting Pronouncements
During June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS 133"). The new standard requires companies to
record derivatives on the balance sheet as assets or liabilities, measured at
fair value. The accounting for gains or losses resulting from changes in the
values of those derivatives would depend on the use of the derivative and
whether it qualifies for hedge accounting. Based on the Company's current
activities, the new standard is not expected to have a material impact on the
Company's financial position or results of operations. SFAS 133 will be
effective for the calendar year beginning January 1, 2001.
On September 28, 1998, the Securities and Exchange Commission ("SEC") issued a
press release stating that it "will formulate and augment new and existing
accounting rules and interpretations covering revenue recognition, restructuring
reserves, materiality and disclosure" for all publicly-traded companies. Until
such time as the SEC staff issues such interpretative guidelines, it is unclear
what, if any, impact such interpretative guidelines will have on the Company's
current accounting policy. However, the potential changes in accounting practice
being considered by the SEC staff could have a material impact on the manner in
which the Company recognizes revenue.
Special Note Regarding Forward Looking Statements
Certain statements in this Quarterly Report on Form 10-Q, including information
appearing under the captions "Management's Discussion and Analysis of Financial
Conditions and Results of Operations" constitute "forward-looking statements"
within the meaning of the Private Securities Litigation Reform Act of 1995 (the
"Reform Act"). The Company desires to take advantage of certain "Safe Harbor"
provisions of the Reform Act and is including this special note to enable the
Company to do so. Forward-Looking Statements involve known and unknown risks,
uncertainties, and other factors which could cause the Company's actual results,
performance (financial or operating) or achievements to differ materially from
the future results, performance (financial or operating) or achievements
expressed or implied by such Forward-Looking Statements. Such risks,
uncertainties and other factors include, among others: the Company's success in
selling new franchises; the economic conditions in the Asian region; the Year
2000 issues, including the success with which the Company's customers and
suppliers address their Year 2000 exposures; as well as more general factors
affecting future cash flows and their effects on the Company's ability to meet
its debt service requirements and future working capital needs, including
fluctuations in foreign currency exchange rates; demand for the Company's
products and services; the impact of competition; the effect of changing
economic and political conditions; the level of success and timing in
implementing corporate strategies and new technologies; changes in governmental
and tax laws and regulations, tax audits and other factors (known or unknown)
which may affect the Company. As a result, no assurance can be given as to
future results, levels of activity and achievements.
33
<PAGE>
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
The Company's major market risk exposure is foreign currency fluctuations.
Geographically, the majority of the Company's subsidiaries are located outside
the United States, with operations conducted in their respective local
currencies. For example, for the three years ended December 31, 1998, the
percentage of total revenues denominated in currencies other than U.S. dollars
averaged 68%, in foreign currencies including the Japanese yen, German mark,
Irish punt, Brazilian real, Mexican peso, British pound and French and Swiss
francs. As discussed under "Management's Discussion and Analysis - Liquidity and
Capital Resources", the Company maintains currency coupon swap agreements with a
financial institution to hedge the Company's net investments in certain foreign
subsidiaries. These agreements require the Company to exchange foreign
currency-denominated interest payments for U.S. dollar-denominated interest
receipts on a semi-annual basis. Significant terms of currency swap agreements
outstanding at June 30, 1999 were as follows:
<TABLE>
<CAPTION>
Interest Payment to Interest Receipts from
Financial Institution Financial Institution
----------------------------------- ------------------------
Notional Fair Value
Effective Interest Amount Interest at 6/30/99
Date Maturity Notional Amount (000's) Rate (000's) Rate (000's)
---- -------- ------------------------- ---- -------- ---- ------
<S> <C> <C> <C> <C> <C> <C> <C>
1/1/99 12/30/02 Japanese Yen 12,311,005 5.50% $95,694 6.27% $(646)
1/1/99 12/31/02 German Mark 99,546 6.12% $55,821 6.27% $ 353
1/4/99 12/31/02 Swiss Franc 16,131 5.72% $11,164 6.27% $ 182
1/4/99 12/31/02 British Pound 4,841 6.56% $ 7,974 6.27% $ (7)
</TABLE>
The fair values of the coupon swap agreements represent the amounts that could
be settled based on estimates obtained from a dealer. The value of these swaps
will be affected by future interest rates and exchange rates.
On March 11, 1999 ("the Issue Date"), the Company issued the Convertible
Debentures, consisting of the Apollo and Benesse Debentures (see Management's
Discussion and Analysis - Liquidity and Capital Resources).
o The Apollo and Benesse Debentures each independently provide for optional
redemption by the Company, in whole but not in part, anytime following 60
trading days after the third anniversary of the Issue Date. If the average
closing price of the Company's common stock for the 30 trading days
following the third anniversary of the Issue Date exceeds $39.66 per share,
the Company may redeem at par. Otherwise, if the Convertible Debentures are
redeemed, the Company shall pay a redemption premium, expressed as a
percentage of outstanding principal, as follows: a) 4% for redemptions
occurring in the fourth year after issue; b) 2% for redemptions occurring
in the fifth year after issue; and c) 0% for redemptions occurring
thereafter. All such redemptions are subject to the holders' rights to
first convert into common stock of the Company.
o The Convertible Debentures also allow Apollo and BHI to elect to exchange
their convertible debentures, in whole, into non-convertible, 7-year fixed
rate debt (the "Fixed Rate Debentures"). Such election may only be made if
the average closing price of the Company's common stock during the 30
trading days immediately preceding the third anniversary of the Issue Date
does not exceed $33.05. Furthermore, BHI may only effect an exchange if
Apollo does so. Upon the determination, by an independent financial
institution, of fixed interest rates that accurately price the Fixed Rate
Debentures at par under specified circumstances at the time of the
exchange, Apollo and BHI shall
34
<PAGE>
irrevocably decide whether to proceed with their exchanges. If only Apollo
proceeds with such an exchange, the Company, no later than 150 days from
the third anniversary of the Issue Date, must either a) redeem all of the
Apollo Debentures at par, or b) deliver the Fixed Rate Debentures to
Apollo. If both Apollo and BHI proceed with their exchanges, the Company,
within the same 150 day period, shall either a) redeem both the Apollo and
Benesse Debentures, or b) deliver the Fixed Rate Debentures to both Apollo
and BHI.
o Principal amounts outstanding under the Fixed Rate Debentures would not be
payable until maturity, while interest payments would be made
semi-annually. The Fixed Rate Debentures interest rate is subject to a cap
of a) the applicable U.S. treasury rate + 5% (not to exceed 13%) if only
Apollo receives Fixed Rate Debentures, or b) the applicable U.S. treasury
rate + 7% (not to exceed 14%) if both Apollo and BHI receives Fixed Rate
Debentures. The Fixed Rate Debentures may be redeemed by the Company after
the third anniversary of their issue upon payment of principal amounts of
the Fixed Rate Debentures and the following redemption premiums, expressed
as a percentage of the outstanding principal amount: a) one half of the per
annum interest rate for redemptions occurring in the fourth year after
issue; b) one quarter of the per annum interest rate for redemptions
occurring in the fifth year after issue; and c) no premium for redemptions
occurring thereafter.
o Prior to the third anniversary of the Issue Date, if Benesse sells 80% or
more of the shares of Berlitz common stock owned directly or indirectly by
it on the Issue Date, the Company shall be required to make an offer to
repurchase for cash: i) the Apollo Debentures at a value equal to 110% of
the principal amount then outstanding; and ii) the Benesse Debentures at a
value equal to 101% of the principal amount then outstanding. In addition,
if at any time on or after the Issue Date a change of control, as defined
in the Investment Agreements, occurs but Benesse sells less than 80% of its
shares, or if Benesse sells 80% of its shares on or after the third
anniversary of the Issue Date, the Company shall be required to make an
offer to repurchase for cash the Convertible Debentures (but not the Fixed
Rate Debentures) at a value equal to 101% of the principal amount of the
Convertible Debentures.
o The fair value of the Convertible Debentures was last estimated at the end
of March, 1999. As of that date the Convertible Debentures had a estimated
fair value of $142.6 million. The estimate was based on current interest
rates and the Company's stock price volatility. The Company does not
believe that this estimate has materially changed at June 30, 1999.
The Company's derivatives are for non-trading purposes. The Company historically
has only entered into derivative contracts as required by its lenders and it has
no present intentions to change this policy. Furthermore, the Company employed
the following procedures to monitor and minimize the market and credit risk
associated with its current derivative contracts entered into pursuant to its
Bank Facility:
a) bids and proposals were obtained from only major financial institutions;
b) prior to entering into its derivative contracts, the Company conferred with
independent advisors to assess the reasonableness of the contracts and
obtained Board of Director approval;
c) the Company entered into simple agreements; and
d) the Company provides status updates regarding its derivatives, including
market value updates, to its Board of Directors on a regular basis.
35
<PAGE>
BERLITZ INTERNATIONAL, INC.
PART II. OTHER INFORMATION
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The 1999 Annual meeting of shareholders was held on June 8, 1999 for the
following purposes:
1. To elect two directors to serve one-year terms until the 2000
annual meeting of shareholders and to elect six directors to serve
two-year terms until the 2001 annual meeting of shareholders;
2. To ratify the selection by the Board of Directors of the Company of
Deloitte & Touche LLP, independent accountants, to audit the
Company's consolidated financial statements for 1999; and
3. To approve the adoption of the Company's 1999 Long Term Executive
Incentive Compensation Plan.
Votes representing 8,718,429 shares were cast for, and 61,353 shares were cast
against or shares abstained from voting on the election of each director. Votes
representing 8,779,496 shares were cast for, 105 shares were cast against, and
181 shares abstained from voting on the ratification of Deloitte & Touche LLP to
audit the Company's 1999 financial statements. Votes representing 8,566,643
shares were cast for, 120,309 shares were cast against, and 194 shares abstained
from voting on the approval of the Company's 1999 Long Term Executive Incentive
Compensation Plan.
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
All exhibits listed below are filed with this Quarterly Report on Form 10-Q.
Exhibit No.
27 Financial Data Schedule, for the quarterly period ended June 30,
1999.
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the quarter ended June 30, 1999.
36
<PAGE>
SIGNATURES
Pursuant to the requirements of the Exchange Act the registrant has duly caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
BERLITZ INTERNATIONAL, INC.
(Registrant)
Date: August 16, 1999 By: /s/ HENRY D. JAMES
------------------------------
Henry D. James
Executive Vice President and
Chief Financial Officer
37
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<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FORM 10-Q OF
BERLITZ INTERNATIONAL, INC. FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1999 AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
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