UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 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 November 12, 1999, is 9,529,788.
Page 1 of 35
<PAGE>
PART I. FINANCIAL INFORMATION,
Item 1. FINANCIAL STATEMENTS
BERLITZ INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
FOR THE THREE MONTHS ENDED SEPTEMBER 30
(Dollars in thousands, except per share amounts)
1999 1998
--------- ---------
Sales of services and products $ 119,497 $ 114,396
--------- ---------
Costs and expenses:
Cost of services and products sold 71,449 65,813
Selling, general and administrative 37,588 36,027
Amortization of publishing rights, excess of cost
over net assets acquired, and other intangibles 4,635 4,310
Interest expense on long-term debt 66 2,648
Interest expense on Convertible Debentures
with related parties 1,995 --
Interest expense on notes to affiliates 656 571
Other expense, net 472 566
--------- ---------
Total costs and expenses 116,861 109,935
--------- ---------
Income before income taxes, minority
interest in earnings of subsidiary, and
extraordinary item 2,636 4,461
Income tax expense 3,533 3,490
Minority interest in earnings
of subsidiaries 57 48
--------- ---------
(Loss) income before extraordinary item (954) 923
Extraordinary loss from extinguishment
of debt 9 --
--------- ---------
Net (loss) income $ (963) $ 923
========= =========
(Loss) income per share - basic and diluted:
(Loss) income before extraordinary item $ (0.10) $ 0.10
Extraordinary loss -- --
--------- ---------
(Loss) income per share $ (0.10) $ 0.10
========= =========
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 NINE MONTHS ENDED SEPTEMBER 30
(Dollars in thousands, except per share amounts)
1999 1998
--------- ---------
Sales of services and products $ 335,041 $ 326,561
--------- ---------
Costs and expenses:
Cost of services and products sold 200,467 190,211
Selling, general and administrative 111,946 105,607
Amortization of publishing rights, excess of cost
over net assets acquired, and other intangibles 13,357 12,925
Interest expense on long-term debt 1,939 8,265
Interest expense on Convertible Debentures
with related parties 4,430 --
Interest expense on notes to affiliates 1,892 1,662
Other (income) expense, net (413) 917
--------- ---------
Total costs and expenses 333,618 319,587
--------- ---------
Income before income taxes, minority
interest in (loss) earnings of subsidiary, and
extraordinary item 1,423 6,974
Income tax expense 5,506 5,174
Minority interest in (loss) earnings
of subsidiaries (122) 154
--------- ---------
(Loss) income before extraordinary item (3,961) 1,646
Extraordinary loss from extinguishment of
debt, net of income tax benefit of $44 2,153 --
--------- ---------
Net (loss) income $ (6,114) $ 1,646
========= =========
(Loss) income per share - basic and diluted:
(Loss) income before extraordinary item $ (0.42) $ 0.17
Extraordinary loss (0.22) --
--------- ---------
(Loss) income per share $ (0.64) $ 0.17
========= =========
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)
September 30, December 31,
1999 1998
--------- ---------
<S> <C> <C>
ASSETS
Current assets:
Cash and temporary investments $ 29,304 $ 25,327
Accounts receivable, less allowance for
doubtful accounts of $3,067 and $2,295 51,576 46,650
Unbilled receivables 14,698 6,873
Inventories, net 10,134 11,606
Prepaid expenses and other current assets 7,595 7,965
--------- ---------
Total current assets 113,307 98,421
Property and equipment, net of accumulated
depreciation of $31,096 and $25,530 45,940 41,144
Publishing rights, net of accumulated amorti-
zation of $5,863 and $5,203 16,122 16,782
Excess of cost over net assets acquired and other intangibles,
net of accumulated amortization of $88,315 and $75,573 486,064 486,232
Other assets 33,844 20,882
--------- ---------
Total assets $ 695,277 $ 663,461
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt $ 1,009 $ 20,135
Accounts payable 7,937 10,228
Deferred revenues 46,872 41,603
Payrolls and commissions 17,045 15,079
Income taxes payable 1,906 365
Due to affiliates 643 --
Accrued expenses and other current liabilities 24,470 18,307
--------- ---------
Total current liabilities 99,882 105,717
Long-term debt 6,260 129,387
Convertible debentures with related parties 155,000 --
Notes payable to affiliates 50,000 42,755
Other liabilities 28,308 20,333
Minority interest 10,148 10,283
--------- ---------
Total liabilities 349,598 308,475
--------- ---------
Shareholders' equity:
Common stock 1,003 1,003
Additional paid-in capital 372,518 372,518
(Accumulated deficit) retained earnings (1,541) 4,574
Treasury stock at cost (6,361) (6,361)
Accumulated other comprehensive loss:
Cumulative translation adjustment (19,940) (16,748)
--------- ---------
Total shareholders' equity 345,679 354,986
--------- ---------
Total liabilities and shareholders' equity $ 695,277 $ 663,461
========= =========
</TABLE>
See accompanying Notes to the Consolidated Financial Statements.
4
<PAGE>
BERLITZ INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Unaudited)
(Dollars in thousands)
<TABLE>
<CAPTION>
Three months ended September 30,
1999 1998
------- -------
<S> <C> <C>
Net (loss) income $ (963) $ 923
Other comprehensive income, net of tax:
Foreign currency items, including translation
adjustments, and the effects of certain
hedges and intercompany transactions 4,956 5,002
------- -------
Comprehensive income $ 3,993 $ 5,925
======= =======
The tax benefit allocated to each component
of other comprehensive income is as
follows:
Foreign currency items $ 1,006 $ 347
======= =======
Nine months ended September 30,
1999 1998
------- -------
Net (loss) income $(6,114) $ 1,646
Other comprehensive (loss) income, net of tax:
Foreign currency items, including translation
adjustments, and the effects of certain
hedges and intercompany transactions (3,192) 2,196
------- -------
Comprehensive (loss) income $(9,306) $ 3,842
======= =======
The tax expense allocated to each
component of other comprehensive loss is as
follows:
Foreign currency items $ (179) $ (600)
======= =======
</TABLE>
See accompanying Notes to the Consolidated Financial Statements.
5
<PAGE>
BERLITZ INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
FOR THE NINE MONTHS ENDED SEPTEMBER 30,
(Dollars in thousands)
<TABLE>
<CAPTION>
1999 1998
--------- ---------
<S> <C> <C>
Cash flows from operating activities:
Net (loss) income $ (6,114) $ 1,646
Adjustments to reconcile net (loss) income to net cash
provided by operating activities:
Depreciation and amortization 21,688 20,337
Other (primarily provision for bad debts and foreign
exchange gains) 670 1,711
Changes in operating assets and liabilities (2,704) 9,442
--------- ---------
Net cash provided by operating activities 13,540 33,136
--------- ---------
Cash flows from investing activities:
Capital expenditures (15,051) (12,925)
Acquisitions of businesses (11,259) (3,347)
--------- ---------
Net cash used in investing activities (26,310) (16,272)
--------- ---------
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
Proceeds from long-term debt 849 --
Repayment of long-term debt (147,113) (12,763)
Repayment of notes to affiliates (42,366) --
Payment of deferred finance costs (2,782) (177)
--------- ---------
Net cash provided by (used in) financing activities 17,588 (8,940)
--------- ---------
Effect of exchange rate changes on cash and
temporary investments (841) 242
--------- ---------
Net increase in cash and temporary investments 3,977 8,166
Cash and temporary investments, beginning of period 25,327 26,665
--------- ---------
Cash and temporary investments, end of period $ 29,304 $ 34,831
========= =========
Supplemental disclosures of cash flow information: Cash payments for:
Interest $ 7,025 $ 8,076
========= =========
Income taxes $ 4,569 $ 6,451
========= =========
Cash refunds of income taxes $ 468 $ 669
========= =========
</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/A, as filed with the Securities and Exchange Commission.
Reclassifications
Certain reclassifications have been made in the prior years' financial
statements and notes to conform with the 1999 presentation.
2. Long-Term Debt
Long-term debt consists of the following:
September 30, December 31,
1999 1998
-------------- -------------
Term Loan $ -- $ 98,250
Revolving credit facility 4,000 48,000
Other 3,269 3,272
-------------- -------------
Total 7,269 149,522
Less current maturities 1,009 20,135
-------------- -------------
Long-term debt $ 6,260 $ 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 September 30, 1999. The average
interest rate on outstanding borrowings under the revolving facility for
the period ending September 30, 1999 was approximately 5.9%.
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
8
<PAGE>
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
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
9
<PAGE>
on the Company's Board of Directors; c) the granting of approval rights to
Apollo, at 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 $2,153, 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
Sept. 30, 1999 Sept. 30, 1998
-------------- --------------
Interest income on temporary investments $(173) $(200)
Foreign exchange losses, net 251 567
Other non-operating taxes 81 165
Loss on disposal of fixed assets 239 37
Other investment expense (income), net 39 (80)
Other expense, net 35 77
----- -----
Total other expense, net $ 472 $ 566
===== =====
10
<PAGE>
Nine months Nine months
Sept. 30, 1999 Sept. 30, 1998
-------------- --------------
Interest income on temporary investments $(430) $(510)
Foreign exchange (gains) losses, net (951) 782
Other non-operating taxes 312 272
Loss on disposal of fixed assets 361 244
Other investment expense (income), net 53 (104)
Other expense, net 242 233
----- -----
Total other (income) expense, net $(413) $ 917
===== =====
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 nine months ended September 30, 1999 and 1998 are as follows:
<TABLE>
<CAPTION>
Weighted
average
number
(Loss) of shares Per-share
Income outstanding amount
-------- ----------- ---------
<S> <C> <C> <C>
Three months ended September 30, 1999:
- --------------------------------------
Basic EPS:
Loss before extraordinary item $ (954) 9,530 $(0.10)
Effect of dilutive securities:
Stock options -- -- --
------- ------- ------
Diluted EPS:
Loss before extraordinary item $ (954) 9,530 $(0.10)
======= ======= ======
Three months ended September 30, 1998:
- --------------------------------------
Basic EPS:
Income before extraordinary item $ 923 9,530 $ 0.10
Effect of dilutive securities:
Stock options -- 28 --
------- ------- ------
Diluted EPS:
Income before extraordinary item $ 923 9,558 $ 0.10
======= ======= ======
Nine months ended September 30, 1999:
- -------------------------------------
Basic EPS:
Loss before extraordinary item $(3,961) 9,530 $(0.42)
Effect of dilutive securities:
Stock options -- -- --
------- ------- ------
Diluted EPS:
Loss before extraordinary item $(3,961) 9,530 $(0.42)
======= ======= ======
Nine months ended September 30, 1998:
- -------------------------------------
Basic EPS:
Income before extraordinary item $ 1,646 9,530 $ 0.17
Effect of dilutive securities:
Stock options -- 27 --
------- ------- ------
Diluted EPS:
Income before extraordinary item $ 1,646 9,557 $ 0.17
======= ======= ======
</TABLE>
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 nine months ended September 30, 1999, the Company recorded $92
and $275, respectively, 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 September 30, 1999, in connection
with this acquisition, the Company's accounts reflected $12,100 of goodwill
and $3,700 of accrued current liabilities for transaction-related expenses
and contingencies.
The Company made several other acquisitions during the first nine months,
none of which were material.
10. Commitments
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. The $4,000 payment at inception may be applied against
future royalties due in excess of the minimum
12
<PAGE>
guarantee. 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 $2,000, 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. Berlitz has recorded the commitment of $6,000 within "Other
liabilities," and a deferred asset of $10,000 within "Other assets."
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 Nine Months ended
September 30, September 30,
------------------ ------------------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenues:
Revenues from external customers:
Language Services:
Instruction $ 68,834 $ 64,956 $ 205,098 $ 198,623
ELS/BOC 20,072 23,318 44,948 52,354
Publishing 3,033 4,406 10,247 11,360
Franchising 306 52 1,015 652
Cross Cultural 725 700 1,957 1,882
Other 1 (11) (1) 0
--------- --------- --------- ---------
Total Language Services 92,971 93,421 263,264 264,871
Berlitz GlobalNET 26,526 20,975 71,777 61,690
--------- --------- --------- ---------
Total external revenues 119,497 114,396 335,041 326,561
--------- --------- --------- ---------
Intersegment revenues:
Language Services:
Instruction -- 9 -- 25
Franchising 35 96 274 443
--------- --------- --------- ---------
Total Language Services 35 105 274 468
Berlitz GlobalNET 102 3 146 16
--------- --------- --------- ---------
Total intersegment revenues 137 108 420 484
--------- --------- --------- ---------
Total revenues for reportable segments 119,634 114,504 335,461 327,045
Elimination of intersegment revenues (137) (108) (420) (484)
--------- --------- --------- ---------
Total consolidated revenues $ 119,497 $ 114,396 $ 335,041 $ 326,561
========= ========= ========= =========
(Loss) income before taxes, minority interest,
and extraordinary item:
Operating Profit:
Segment EBITA:
Language Services:
Instruction $ 12,996 $ 12,848 $ 39,654 $ 41,345
ELS/BOC 2,946 4,135 2,682 5,924
Publishing 35 738 598 1,172
Franchising 124 (207) 210 (162)
Cross Cultural 165 212 403 503
Language Service overhead expenses and
other (4,896) (4,530) (15,456) (13,866)
--------- --------- --------- ---------
Total Language Services 11,370 13,196 28,091 34,916
Berlitz GlobalNET 2,192 2,440 4,481 5,218
General corporate HQ expenses (3,102) (3,080) (9,944) (9,391)
--------- --------- --------- ---------
Total EBITA 10,460 12,556 22,628 30,743
--------- --------- --------- ---------
Amortization of publishing rights, excess of
cost over net assets acquired, and other
intangibles:
Language Services:
Instruction (2,567) (2,518) (7,638) (7,590)
ELS/BOC (1,356) (1,349) (4,051) (4,045)
Publishing (100) (99) (299) (299)
Cross Cultural (3) (2) (8) (8)
--------- --------- --------- ---------
Total Language Services (4,026) (3,968) (11,996) (11,942)
Berlitz GlobalNET (609) (342) (1,361) (983)
--------- --------- --------- ---------
Total intangible amortization (4,635) (4,310) (13,357) (12,925)
--------- --------- --------- ---------
Total operating profit 5,825 8,246 9,271 17,818
Interest expense on long-term debt (66) (2,648) (1,939) (8,265)
Interest expense on Convertible Debentures (1,995) -- (4,430) --
Interest expense to affiliates (656) (571) (1,892) (1,662)
Other income (expense), net (472) (566) 413 (917)
--------- --------- --------- ---------
Total consolidated income (loss) before taxes,
minority interest, and extraordinary item $ 2,636 $ 4,461 $ 1,423 $ 6,974
========= ========= ========= =========
</TABLE>
14
<PAGE>
Assets: September 30, December 31,
1999 1998
------------- ------------
Language Services:
Instruction $430,949 $426,818
ELS/BOC 108,806 111,980
Publishing 25,066 23,982
Franchising 6,997 6,553
Other 11,691 (62)
-------- --------
Total Language Services 583,509 569,271
Berlitz GlobalNET 102,403 85,193
General corporate 14,914 13,495
Eliminations of intersegment receivables (5,549) (4,498)
-------- --------
Total consolidated assets $695,277 $663,461
======== ========
<TABLE>
<CAPTION>
Three Months ended Sept. 30, Nine Months ended Sept. 30,
---------------------------- ---------------------------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Depreciation:
Language Services:
Instruction $ 1,300 $ 1,230 $ 3,752 $ 3,520
ELS/BOC 251 254 741 711
Publishing 469 376 1,310 869
Franchising 4 5 14 20
Language Service overhead and
other 121 109 358 332
------- ------- ------- -------
Total Language Services 2,145 1,974 6,175 5,452
Berlitz GlobalNET 612 520 1,653 1,547
General corporate 210 148 503 412
------- ------- ------- -------
Total consolidated depreciation $ 2,967 $ 2,642 $ 8,331 $ 7,411
======= ======= ======= =======
Capital expenditures:
Language Services:
Instruction $ 3,293 $ 2,295 $10,344 $ 7,923
ELS/BOC 96 194 673 479
Publishing 521 356 1,891 1,857
Franchising 2 -- 32 --
------- ------- ------- -------
Total Language Services 3,912 2,845 12,940 10,259
Berlitz GlobalNET 235 1,361 901 2,133
General corporate 339 213 1,210 533
------- ------- ------- -------
Total consolidated capital
expenditures $ 4,486 $ 4,419 $15,051 $12,925
======= ======= ======= =======
</TABLE>
The following tables present certain information about the geographic areas in
which the Company operates:
<TABLE>
<CAPTION>
Three Months ended Nine Months ended
September 30, September 30,
---------------------- ----------------------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenues from external customers:
United States $ 42,616 $ 48,456 $111,223 $121,343
Japan 19,526 13,808 51,770 42,757
Germany 10,192 10,795 31,703 30,378
Ireland 7,266 5,042 17,798 18,724
France 4,863 4,328 15,606 12,397
Brazil 3,814 5,402 10,679 16,104
Other foreign countries 31,220 26,565 96,262 84,858
-------- -------- -------- --------
Total $119,497 $114,396 $335,041 $326,561
======== ======== ======== ========
</TABLE>
15
<PAGE>
<TABLE>
<CAPTION>
Three Months ended Nine Months ended
Sept. 30, Sept. 30,
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Operating (loss) profit:
EBITA :
United States $ 5,355 $ 8,760 $ 10,834 $ 16,099
Japan 3,152 1,563 5,002 4,570
Germany 862 1,474 3,320 4,130
Ireland 753 592 1,030 1,623
France 325 135 1,373 544
Brazil 465 825 1,369 2,432
Other foreign countries 3,679 3,258 12,938 13,482
General corporate expenses (4,131) (4,051) (13,238) (12,137)
--------- --------- --------- ---------
Total EBITA 10,460 12,556 22,628 30,743
--------- --------- --------- ---------
Amortization of publishing rights,
excess of cost over net assets
acquired, and other intangibles:
United States (3,895) (3,583) (11,182) (10,746)
Japan (357) (278) (1,017) (872)
Germany (66) (65) (195) (193)
Ireland (12) (13) (36) (61)
France (70) (74) (216) (150)
Brazil (16) (16) (48) (48)
Other foreign countries (219) (281) (663) (855)
--------- --------- --------- ---------
Total intangible amortization (4,635) (4,310) (13,357) (12,925)
--------- --------- --------- ---------
Intercompany royalties:
United States 5,031 3,881 12,614 11,648
Japan (2,469) (1,193) (3,992) (3,159)
Germany (369) (360) (1,184) (1,109)
Ireland (363) (249) (888) (927)
France (243) (315) (775) (808)
Other foreign countries (1,587) (1,764) (5,775) (5,645)
--------- --------- --------- ---------
Total intercompany royalties -- -- -- --
--------- --------- --------- ---------
Total operating profit $ 5,825 $ 8,246 $ 9,271 $ 17,818
========= ========= ========= =========
<CAPTION>
Long lived assets: Property &
Equipment Other Intangible
net Assets* Assets Total
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
September 30, 1999:
United States $ 10,565 $ 8,165 $ 402,089 $ 420,819
Japan 10,092 86 51,343 61,521
Germany 3,274 -- 8,608 11,882
France 1,851 -- 6,349 8,200
Brazil 2,787 -- 2,097 4,884
Ireland 920 1 1,603 2,524
Other foreign countries 11,526 265 28,501 40,292
General corporate and HQ 4,925 13,923 1,596 20,444
--------- --------- --------- ---------
Total $ 45,940 $ 22,440 $ 502,186 $ 570,566
========= ========= ========= =========
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.
Results of Operations - Quarter Ended September 30, 1999 vs. September 30, 1998
Sales for the quarter ended September 30, 1999 were $119.5 million, 4.5% above
the prior year. This rise was primarily due to increases in operating activity
for Language Instruction and Berlitz GlobalNET, partially offset by reduced
revenues for ELS/BOC and Publishing. Excluding the effects of unfavorable
exchange rate fluctuations of $0.9 million, sales increased from the prior year
by 5.3%. The following table compares revenues by business segment for the third
quarter.
<TABLE>
<CAPTION>
Business Segment Revenues: (Dollars in millions)
---------------------------------------------------------
September 30, Growth (Decline) from Prior Year
------------------ ------------------------------------
1999 1998 Exchange(2) Operations(1) Total
------ ------ ----------- ------------- ------
<S> <C> <C> <C> <C> <C>
Language Services:
Instruction $ 68.8 $ 65.0 $ (0.4) $ 4.2 $ 3.8
ELS/BOC 20.1 23.3 -- (3.2) (3.2)
Publishing 3.0 4.4 (0.1) (1.3) (1.4)
Franchising 0.3 0.1 -- 0.2 0.2
Other 0.8 0.6 0.1 0.1 0.2
------ ------ ------ ------ ------
Total Language Services 93.0 93.4 (0.4) 0.0 (0.4)
Berlitz GlobalNET 26.6 21.0 (0.5) 6.1 5.6
Eliminations (0.1) -- -- (0.1) (0.1)
------ ------ ------ ------ ------
Total $119.5 $114.4 $ (0.9) $ 6.0 $ 5.1
====== ====== ====== ====== ======
</TABLE>
- ----------------------
(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 ($0.9 million) primarily resulted
from a strengthened dollar against the Latin American currencies (most
significantly the Brazilian real) and all
17
<PAGE>
European currencies, offset by a weaker dollar against the Japanese yen.
Within Language Services, Language Instruction sales for the 1999 third quarter
rose 6.0% from the prior year, and excluding unfavorable exchange rate
fluctuations, were 6.6% higher than in 1998. This improvement was primarily due
to average revenue per lesson ("ARPL") increases in most countries and higher
lesson volume in Japan, Germany, Israel, Mexico and France. Total lesson volume
increased 1.8% from the prior year, primarily as strength in Asia and Europe was
offset by weakness in North America. Geographically, Language Instruction
revenue and lesson volume was dispersed as follows:
Language Instruction
Revenue: (Dollars in millions)
---------------------------------------------------------
September 30, Growth (Decline) from Prior Year
--------------- ------------------------------------
1999 1998 Exchange Operations Total
----- ----- -------- ---------- -----
North America $12.4 $13.2 $ 0.1 $(0.9) $(0.8)(1)
Asia 19.4 14.3 3.6 1.5 5.1(2)
Latin America 12.4 13.8 (2.7) 1.3 (1.4)(3)
Europe 24.6 23.7 (1.4) 2.3 0.9(4)
----- ----- ----- ----- -----
Total revenue $68.8 $65.0 $(0.4) $ 4.2 $ 3.8
===== ===== ===== ===== =====
- -------------------------------------
(1) Decline was due to lesson volume shortfalls in the USA.
(2) Primarily reflected the effect of a weaker US dollar against the Japanese
yen, as well as increased lesson volume in Japan due to a special sales
campaign.
(3) Primarily reflected the effect of a stronger dollar against the Brazilian
real, partially offset by volume and ARPL increases in Mexico.
(4) Primarily reflected improved volume and ARPL in most countries (in
particular Belgium, France, Germany, Israel, and Poland), partly offset by a
strengthened dollar against all European currencies.
Language Instruction
Lesson Volume: (Lessons in thousands)
---------------------------------------------------
September 30, Growth (Decline) from Prior Year
----------------- --------------------------------
Number of
1999 1998 lessons Percentage
------- ------- --------- ----------
North America 273.2 299.4 (26.2) (8.8)%(1)
Asia 291.0 267.7 23.3 8.7% (2)
Latin America 359.2 355.2 4.0 1.1% (3)
Europe 534.8 509.5 25.3 5.0% (4)
------- ------- -------
Total lesson volume 1,458.2 1,431.8 26.4 1.8%
======= ======= =======
- -------------------------------------
(1) North America's volume decline continued to primarily reflect reduced
institutional training volume in the petroleum and financial service
sectors, and a decrease in expatriations; Hurricane Floyd was estimated to
account for approximately 3.0 lessons of the lesson shortfall.
(Footnotes are continued on next page)
18
<PAGE>
(2) Asia's volume improved largely due to a special summer sales campaign in
Japan.
(3) Lesson volume increased in Latin America primarily due to strong sales in
Mexico, Peru, Uruguay and Puerto Rico. Lesson volume was down in Chile,
Colombia, Venezuela and Argentina due to difficult economic environments in
these countries.
(4) Europe's volume improvement reflected continued demand for Berlitz services,
with the largest increases generated by Israel, Germany, France, and Poland.
For the third quarter of 1999, ARPL was $41.14, as compared to $40.51 in the
comparable prior-year period. Excluding the unfavorable impact of exchange rate
fluctuations of ($0.40), ARPL increased over prior year by $1.02. ARPL ranged
from a high of approximately $61.76 in Japan to a low of $15.10 in Thailand,
reflecting effects of foreign exchange rates and differences in the economic
value of the service.
Within Language Services, combined ELS/BOC revenues for the third quarter
declined 13.9% from the prior year. The strong U.S. dollar and economic
instability in Latin America caused mixed results within the region (for
example, decreased student applications from Brazil but increased student
applications from Colombia). Despite this, overall worldwide student
applications showed some positive trends, most notably in Korea and Taiwan. To
bolster revenues, major sales and promotional activities are underway to inform
new and existing sales agents about the new consolidated ELS Language Centers
network that includes an extensive choice of centers in all major geographic
regions within the United States. Further, ELS has and continues to disseminate
information and collateral materials to its sales agents announcing new programs
and pricing for the year 2000. In addition, a major website project was
initiated to support agent sales, as well as direct marketing and relationship
marketing efforts.
Publishing revenues were $1.4 million, or 31.2%, below the prior year. The prior
year's quarter benefited from a large sale to a German distributor. Franchising
revenues more than doubled from the prior year. During the quarter, the Company
opened one Berlitz language center in each of France and Japan and six Berlitz
franchises opened.
Berlitz GlobalNET sales, excluding the effects of exchange rate fluctuations,
rose 29.4% from 1998. Geographically, sales are above prior year in all regions.
The following table compares Berlitz GlobalNET revenues by region for the third
quarter:
19
<PAGE>
<TABLE>
<CAPTION>
Berlitz GlobalNET Revenue: (Dollars in millions)
--------------------------------------------------------------
September 30, Growth (Decline) from Prior Year
-------------------------- --------------------------------
1999 1998 Exchange Operations Total
---- ---- ----- ----- -----
<S> <C> <C> <C> <C> <C>
America $11.9 $11.3 $ -- $ 0.6 $ 0.6(1)
Asia 1.8 1.2 0.2 0.4 0.6(2)
Europe 14.5 10.2 (0.8) 5.1 4.3(3)
Inter-company eliminations (1.6) (1.7) 0.1 -- 0.1
----- ----- ----- ----- -----
Total revenue (4) $26.6 $21.0 $(0.5) $ 6.1 $ 5.6
===== ===== ===== ===== =====
</TABLE>
(1) North America's increase primarily reflected results generated by a
business acquired in June 1999, partially offset by lower volume due to the
timing of projects in the automotive industry.
(2) Asia's increase reflected improved volume in Japan, as well as the results
of an acquired business.
(3) The sales increase in Europe was attributable to volume increases in
Ireland, Norway and France, and sales from acquisitions made in Poland in
the fourth quarter of 1998. The volume increases reflect the influx of
major projects which were delayed from prior quarters.
(4) Many clients, as well as prospective clients, have delayed projects
scheduled for 1999 due to the uncertainty of buyer behavior related to Year
2000 issues, waiting to release new products until after the new year. This
has had a negative effect on third and anticipated fourth quarter
production volumes.
The total Company's cost of services and products sold as a percentage of sales
was 59.8% in the 1999 third quarter, compared to 57.5% in the same prior year
period. The higher percentage is mainly attributable to higher teacher costs,
lower GlobalNET production margins, an increase in the provision for doubtful
accounts, and higher rent over the prior year. Selling, general and
administrative expenses as a percentage of sales were 31.5% in the 1999 third
quarter, flat with the comparable prior year period, primarily as higher
administrative salaries and related costs were offset by reduced sales
commissions for ELS/BOC.
The Company's total EBITA* for the 1999 third quarter was $10.5 million, or 8.8%
of sales, compared to $12.6 million, or 11.0% of sales, in the same prior year
period. The following table displays the comparative third quarter EBITA by
business segment:
Business Segment EBITA: (Dollars in millions)
----------------------------------------------------
September 30, Growth (Decline) from Prior Year
---------------- --------------------------------
1999 1998 Exchange Operations Total
----- ----- -------- ---------- -----
Language Services:
Instruction $13.0 $12.8 $ 0.1 $ 0.1(1) $ 0.2
ELS/BOC 2.9 4.1 -- (1.2)(2) (1.2)
Publishing -- 0.7 -- (0.7)(3) (0.7)
Franchising 0.1 (0.2) -- 0.3 0.3
Overhead & Other (4.6) (4.2) 0.1 (0.5)(4) (0.4)
----- ----- ----- ----- -----
Total Language Services 11.4 13.2 0.2 (2.0) (1.8)
Berlitz GlobalNET 2.2 2.4 (0.1) (0.1)(5) (0.2)
Corporate and other (3.1) (3.0) -- (0.1) (0.1)
----- ----- ----- ----- -----
Total $10.5 $12.6 $ 0.1 $(2.2) $(2.1)
===== ===== ===== ===== =====
(Footnotes, including "*", are continued on next page)
20
<PAGE>
EBITA Margin %: September 30,
------------------------
1999 1998
--------- ----------
Language Services:
Instruction (6) 18.9% 19.8%
ELS/BOC (2) 14.7% 17.7%
Publishing (3) 1.2% 16.8%
Franchising 36.3% (140.0)%
Total Language Services 12.2% 14.1%
Berlitz GlobalNET (5) 8.2% 11.6%
Total 8.8% 11.0%
- ----------
(1) The flat Instruction operating EBITA was primarily affected by weakness in
the North American region, certain Latin American countries, and Poland. In
North America, the combined effect of decreased volume and increases in
teacher salaries, rent expense, administrative salaries and bad debt
expense led to a decline over prior year. In Latin America, economic
instability in Argentina, Brazil, Colombia and Venezuela led to EBITA
declines in these countries. In Poland, the quarter's EBITA was negatively
impacted by new legislation on teachers' social security.
(2) Despite reductions in its overall costs from the prior year, ELS/BOC's
EBITA and EBITA margin decreased because cost cutting did not cover the
shortfalls in sales. In addition, an ELS joint venture in Japan consummated
in October 1998 generated an EBITA loss of $0.3 million in the third
quarter of 1999 due to its start-up nature.
(3) Publishing's 1998 EBITA and EBITA margin benefited from certain items
(including a large sale to a German distributor, and a bad debt recovery)
which were absent in 1999.
(4) Language Service's overhead costs increased over the prior year due to
increases in advertising and certain administrative expenses.
(5) Berlitz GlobalNET's flat EBITA and reduced EBITA margin was impacted by
breakeven EBITA for a June 1999 acquisition as it was integrated into the
Company. Implementation of organizational changes at this acquisition have
built a base for future margin improvements. Overall EBITA was also
adversely affected by temporary operational and administrative
inefficiencies associated with the implementation of new systems at the
Company's Washington D.C. location; such implementation is now
substantially complete.
(6) The reduction in Instruction's 1999 EBITA margin occurred primarily as
teacher costs, rent, and provision for doubtful accounts grew faster than
revenues.
21
<PAGE>
- --------------------------------------------------------------------------------
*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.
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"). As a result of these transactions,
the Company's combined interest expense on long-term debt and convertible
debentures for the third quarter of 1999 decreased $0.6 million from the
comparable prior year period, due principally to a reduced effective interest
rate.
The Company recorded third quarter income tax expenses of $3.5 million in both
1999 and 1998. 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 - Nine Months Ended September 30, 1999 vs. September 30,
1998
Sales for the nine months ended September 30, 1999 were $335.0 million, 2.6%
above the prior year. The sales growth was primarily due to activity generated
from the Language Instruction and Berlitz GlobalNET business segments, which was
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 $4.4 million, sales increased from the prior year
by 3.9%. The following table compares revenues by business segment for the first
nine months of the year.
<TABLE>
<CAPTION>
Business Segment
Revenues: (Dollars in millions)
--------------------------------------------------------------
September 30, Growth (Decline) from Prior Year
------------------ --------------------------------------
1999 1998 Exchange(2) Operations(1) Total
------ ------ ----------- ------------- -----
<S> <C> <C> <C> <C> <C>
Language Services:
Instruction $205.1 $198.6 $(3.6) $10.1 $ 6.5
ELS/BOC 44.9 52.4 (0.1) (7.4) (7.5)
Publishing 10.2 11.4 (0.1) (1.1) (1.2)
Franchising 1.3 1.1 -- 0.2 0.2
Other 1.8 1.4 0.2 0.2 0.4
------ ------ ----- ----- -----
Total Language Services 263.3 264.9 (3.6) 2.0 (1.6)
Berlitz GlobalNET 71.9 61.7 (0.7) 10.9 10.2
Eliminations (0.2) -- (0.1) (0.1) (0.2)
------ ------ ----- ----- -----
Total $335.0 $326.6 $(4.4) $12.8 $ 8.4
====== ====== ===== ===== =====
</TABLE>
- ----------
(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 ($4.4 million) primarily resulted
from a strengthened dollar against the Latin American currencies (most
significantly the Brazilian real) and all
22
<PAGE>
European currencies, offset by a weaker dollar against the Japanese yen.
Within Language Services, Language Instruction sales for the first nine months
of 1999 rose 3.2% from the prior year, and excluding unfavorable exchange rate
fluctuations, were 5.0% higher than in 1998. This improvement was primarily due
to ARPL increases in most countries. Total lesson volume increased 1.3% from the
prior year, primarily as strength in Germany, France, Mexico and Israel was
offset by weakness in Asia and the USA.
Geographically, Language Instruction revenue and lesson volume was dispersed as
follows:
Language Instruction
Revenue: (Dollars in millions)
---------------------------------------------------------
September 30, Growth (Decline) from Prior Year
---------------- ----------------------------------
1999 1998 Exchange Operations Total
------ ------ -------- ---------- ---------
North America $ 36.5 $ 38.1 $ (0.2) $ (1.4) $ (1.6)(1)
Asia 51.5 44.1 6.7 0.7 7.4(2)
Latin America 35.6 40.3 (8.1) 3.4 (4.7)(3)
Europe 81.5 76.1 (2.0) 7.4 5.4(4)
------ ------ ------ ------ ------
Total revenue $205.1 $198.6 $ (3.6) $ 10.1 $ 6.5
====== ====== ====== ====== ======
- ----------
(1) Decline was due to lesson volume shortfalls in the USA.
(2) Primarily reflected the effect of a weaker US dollar against the Japanese
yen.
(3) Primarily reflected the effect of a stronger dollar against all Latin
America currencies, primarily the Brazilian real, partially offset by volume
and ARPL increases in Mexico.
(4) Primarily reflected improved volume and ARPL in most countries (in
particular Belgium, France, Germany, Israel, and Poland), as well as
unfavorable exchange rate fluctuations in Germany, Israel and Poland.
Language Instruction
Lesson Volume: (Lessons in thousands)
---------------------------------------------------------
September 30, Growth (Decline) from Prior Year
---------------------- --------------------------------
Number of
1999 1998 lessons Percentage
------- ------- ------- ----------
North America 840.4 886.9 (46.5) (5.2)%(1)
Asia 791.2 792.3 (1.1) (0.1)%(2)
Latin America 1,015.8 993.1 22.7 2.3%(3)
Europe 1,823.1 1,738.8 84.3 4.8%(4)
------- ------- -----
Total lesson volume 4,470.5 4,411.1 59.4 1.3%
======= ======= =====
- ----------
(1) North America's volume decline primarily reflected 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.
23
<PAGE>
(2) Asia's volume remained flat as economic pressures in Japan and Hong Kong
were offset by a special summer sales campaign in Japan.
(3) Lesson volume increased in Latin America primarily due to strong sales in
Mexico and Peru. Lesson volume was down in Venezuela, Argentina, Chile and
Colombia due to uncertain economies in these countries.
(4) Europe's volume improvement reflected continued growth in the region, with
the largest increases generated by Germany, Israel, France, and Poland. Both
Israel and Poland had new school openings during the first half of 1999,
which contributed to the improved volume.
For the first nine months of 1999, ARPL was $40.66, as compared to $40.42 in the
comparable prior-year period. The increase reflected the favorable impact of
product mix and price increases (i.e., $1.06), partly offset by the effects of
unfavorable exchange rate fluctuations ($0.83). ARPL ranged from a high of
approximately $60.48 in Japan to a low of $15.28 in Thailand, reflecting effects
of foreign exchange rates and differences in the economic value of the service.
Within Language Services, ELS/BOC revenues declined 14.1% from the prior year.
ELS/BOC was affected by weakened Asian student enrollments due to the economic
conditions in the Far East, although applications began to show some positive
trends in the 1999 third quarter. Enrollments from Latin America were also down
due to economic instability in Venezuela and Brazil, and the increased strength
of the dollar over the currencies in these countries. Aggressive pricing and
agent commission structures by competitors 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 aggressively in the latter months of 1998
and early part of 1999 due to perceived uncertainties about the future of ELS
programs. This impacted student arrivals during the first and second quarters of
1999. ELS/BOC has taken actions to address these matters, including filling
vacant sales positions and articulating its new business plan to its agents, and
monitoring and reducing overhead expenses. To bolster revenues, major sales and
promotional activities are underway to inform new and existing sales agents
about the new consolidated ELS Language Centers network that includes an
extensive choice of centers in all major geographic regions within the United
States. Further, ELS has and continues to disseminate information and collateral
materials to its sales agents announcing new programs and pricing for the year
2000. In addition, a major website project was initiated to support agent sales,
as well as direct marketing and relationship marketing efforts.
Publishing revenues declined $1.1 million, or 9.8%, from the prior year. A large
sale to a German distributor in 1998 benefited the 1998 results. Franchising
revenues increased 17.7% from the prior year. ELS added a net of 4 franchises
and Berlitz added 7 franchises during the first nine months of 1999.
Berlitz GlobalNET sales, excluding the unfavorable effects of exchange rate
fluctuations, rose 17.7% from 1998. Geographically, sales were above prior year
in all regions. The following table compares Berlitz GlobalNET revenues by
region for the nine months:
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<PAGE>
Berlitz GlobalNET Revenue: (Dollars in millions)
-------------------------------------------------
September 30, Growth (Decline) from Prior Year
-------------- --------------------------------
1999 1998 Exchange Operations Total
----- ----- -------- ---------- -------
America $32.3 $29.3 $(0.1) $ 3.1 $ 3.0(1)
Asia 4.2 3.2 0.4 0.6 1.0(2)
Europe 39.1 32.7 (1.0) 7.4 6.4(3)
Inter-company eliminations (3.7) (3.5) -- (0.2) (0.2)
----- ----- ----- ----- -----
Total revenue $71.9 $61.7 $(0.7) $10.9 $10.2
===== ===== ===== ===== =====
(1) Sales were higher than prior year in the North America due to results from
a business acquired in June 1999, and continued strength in traditional
business.
(2) The sales increase in Asia reflected volume increases in Japan, and an
acquired business in Singapore.
(3) The sales increase in Europe reflected volume increases in Norway and
Denmark, and sales from acquisitions made in France and Poland in the
second and fourth quarters of 1998, respectively.
The total Company's cost of services and products sold as a percentage of sales
was 59.8% in the 1999 first nine months, compared to 58.2% in the same prior
year period. The higher percentage was mainly attributable to higher teacher
salaries, a decline in GlobalNET production margins, and higher rent expense.
Selling, general and administrative expenses as a percentage of sales were 33.4%
in the first nine months of 1999, compared with 32.3% in the comparable prior
year period. The increase was due primarily to higher administrative salaries.
The total Company's EBITA for the first nine months of 1999 was $22.6 million,
or 6.8% of sales, compared to $30.7 million, or 9.4% of sales, in the same prior
year period. The following table displays the comparative EBITA for the first
nine months of the year by business segment:
Business Segment EBITA: (Dollars in millions)
-----------------------------------------------------
September 30, Growth (Decline) from Prior Year
---------------- --------------------------------
1999 1998 Exchange Operations Total
----- ----- -------- ---------- ------
Language Services:
Instruction $39.7 $41.3 $(1.1) $(0.5)(2) $(1.6)
ELS/BOC 2.7 5.9 -- (3.2)(3) (3.2)
Publishing 0.6 1.2 -- (0.6)(4) (0.6)
Franchising 0.2 (0.2) -- 0.4 0.4
Overhead & Other (15.1) (13.3) 0.3 (2.1)(5) (1.8)
----- ----- ----- ----- -----
Total Language Services 28.1 34.9 (0.8) (6.0) (6.8)
Berlitz GlobalNET 4.5 5.2 (0.1) (0.6)(6) (0.7)
Corporate and other (10.0) (9.4) -- (0.6)(7) (0.6)
----- ----- ----- ----- -----
Total $22.6 $30.7 $(0.9)(1) $(7.2) $(8.1)
===== ===== ===== ===== =====
25
<PAGE>
EBITA Margin %: September 30,
------------------------
1999 1998
--------- ---------
Language Services:
Instruction (8) 19.3% 20.8%
ELS/BOC (3) 6.0% 11.3%
Publishing (4) 5.8% 10.3%
Franchising 20.6% 26.7%
Total Language Services 10.7% 13.2%
Berlitz GlobalNET (9) 6.2% 8.5%
Total 6.8% 9.4%
- ----------
(1) The net unfavorable foreign exchange impact was attributable mainly to the
Latin American countries.
(2) The decline in Instruction operating EBITA was due mainly to weakness in
the U.S., Poland, and certain Latin American countries. In the U.S., growth
in teacher and administrative salaries, rent and certain other fixed costs,
coupled with a lesson volume decline, led to lower EBITA and EBITA margins.
In Latin America, economic uncertainty in Argentina, Brazil, Colombia and
Venezuela led to EBITA declines in these countries. In Poland, the EBITA
was negatively impacted by new legislation on teachers' social security.
The decreases in these countries were partially offset by EBITA increases
primarily in Mexico and most European countries, notably; France, Austria,
Denmark, and Belgium.
(3) Despite reductions in its overall costs from the prior year, ELS/BOC's
EBITA and EBITA margin decreased because the percentage decline in ELS'
revenues outpaced the percentage decline of certain costs (most notably
teachers' salaries, advertising and rent expense). In addition, an ELS
joint venture in Japan consummated in October 1998 generated an EBITA loss
of $0.8 million in the first nine months of 1999 due to its start-up
nature.
(4) Publishing's 1998 EBITA and EBITA margin benefited from certain items
(including a large sale to a German distributor, and a bad debt recovery)
which were absent in 1999.
(5) Language Service's overhead cost increase over prior year was attributable
to fixed employee costs, advertising and travel expenses.
(6) The decline in EBITA for Berlitz GlobalNET was due to decreases in the
Americas and Asia, primarily in the USA where the integration of an
acquisition and the implementation of a case management system at our
Washington, D.C. location temporarily impacted results. These declines were
partially offset by strength in Europe and increased activity in France and
Poland from acquisitions made in the second and fourth quarters of 1998,
respectively.
(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 U.S.
locations, and increases in administrative positions.
As a result of the March 1999 issuance of Convertible Debentures and an
affiliate note, and the related extinguishment of existing long-term debt, the
Company's combined interest expense on long-term debt and convertible debentures
for the nine months ended September 30, 1999 decreased $1.9 million from the
prior year. This decrease was due principally to a reduced effective interest
rate.
Other income, net for the nine months ended September 30, 1999 increased by $1.3
million
26
<PAGE>
over the prior year, primarily due to foreign exchange gains.
The Company recorded income tax expenses of $5.5 million and $5.2 million in
first nine months of 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.
In connection with March 1999 extinguishment of long-term debt, 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 nine months of 1999, the Company has recorded an extraordinary loss, net
of tax benefit, of approximately $2.2 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 provided by operating activities was $13.5 million and $33.1 million
for the nine months ended September 30, 1999 and 1998, respectively. This
decline of $19.6 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 $26.3 million for the nine months
ended September 30, 1999, up $10.0 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 nine months of 1999 increased $2.1 million over the
prior year.
Net cash provided by financing activities for the nine months ended September
30, 1999 was $17.6 million, $26.5 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 September 30, 1999 were $1.3 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"). CTW will create and produce,
at its expense, a television series, entitled "Sesame English", which will
initially consist of 52 15-minute episodes and which will be complemented
by instruction curricula and materials developed by Berlitz. Berlitz was
also granted certain rights by CTW, including the exclusive right to
27
<PAGE>
use certain Sesame Street and Sesame English names, logos and characters in
connection with language instructional products, services and schools.
o 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. The $4 million paid at inception may be applied
against future royalties due in excess of the minimum guarantee.
Furthermore, 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. ("LMI"), 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 September 30, 1999, in connection
with this acquisition, the Company recorded $12.1 million of goodwill and
accrued $3.7 million in 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 September 30, 1999.
28
<PAGE>
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.
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 September
30, 1999, representing the amount that could be settled based on estimates
obtained from a dealer, was a net liability of approximately $3.0 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 September 30, 1999, the Company's liquid assets of $29.3 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
29
<PAGE>
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.
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 dedicated to addressing any
possible areas of exposure. This committee is responsible for carrying out the
Company's Year 2000 Project (the "Project"), comprised of conducting a corporate
awareness program, assessing key financial and operational systems, assessing
external relationships with customers and vendors, and developing and
implementing detailed divisional action plans. The committee reports to
executive management and the Board of Directors regularly to maintain awareness
of the Project status.
The Company 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. Where appropriate, non-compliant
internal use financial software has been replaced in conjunction with the
deployment of PeopleSoft systems. Such PeopleSoft systems have been warranted to
be Year 2000 compliant by the vendor 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
All elements of the Company's Year 2000 Project are now substantially complete
as per the originally scheduled September 29, 1999 target. As anticipated,
remaining Project efforts will be directed primarily toward continuing
recertification of compliant systems and ongoing evaluation of key third
parties' readiness.
With regard to infrastructure and internal use financial and operational systems
areas, the Company chose to replace rather than upgrade most non-compliant
systems without commercially available remediation paths at the time of
assessment. In order to achieve timely completion of system replacement
projects, the Company employed both internal and external resources in its
remediation efforts.
30
<PAGE>
Scheduled remediation and testing of internal systems was substantially complete
as of September 29, 1999. System testing was conducted in line with remediation
efforts; as systems were upgraded or replaced, compliance testing of the system
was conducted.
The Company will continue to monitor new releases and updates of vendor-supplied
software, and will test and apply new releases as necessary for Year 2000
compliance.
The Company has substantially completed a formal communications program with all
key vendors and customers to identify and assess their states of readiness.
Based on an assessment of third parties' disclosed states of readiness, the
Company does not anticipate any significant material impact on continued
operations due to third party Year 2000-related failures. As the readiness of
third parties is beyond the control of the Company, communications with and
assessment of key third parties will continue to minimize any exposure to the
Company and ensure its ability to conduct normal business as the Year 2000
approaches.
Risk
The Company has substantially completed Project activities related to internal
compliance and does not believe that any reasonably likely risk of material
failure exists. Based on management estimates and the Company's inability 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 or fail to disclose their Year 2000 readiness
completely or accurately. Such 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 initiate contingency plans related
to the remediation and deployment of internally developed software have been
effected as necessary.
31
<PAGE>
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 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
32
<PAGE>
Company. As a result, no assurance can be given as to future results, levels of
activity and achievements.
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 September 30, 1999 were as follows:
<TABLE>
<CAPTION>
Interest Receipts from
Interest Payment to Financial Institution Financial Institution
----------------------------------------- ---------------------
Notional Fair Value
Effective Interest Amount Interest at 9/30/99
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% $(3,223)
1/1/99 12/31/02 German Mark 99,546 6.12% $55,821 6.27% $ 147
1/4/99 12/31/02 Swiss Franc 16,131 5.72% $11,164 6.27% $ 144
1/4/99 12/31/02 British Pound 4,841 6.56% $ 7,974 6.27% $ (60)
</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
33
<PAGE>
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 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 September 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:
34
<PAGE>
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 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 September
30, 1999.
(b) Reports on Form 8-K
A report on Form 8-K, dated July 1, 1999, was filed during the quarter ended
September 30, 1999 to announce the Company's license agreement with Children's
Television Workshop ("CTW").
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: November 15, 1999 By: /s/ HENRY D. JAMES
---------------------------------
Henry D. James
Executive Vice President and
Chief Financial Officer
36
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FORM 10-Q OF
BERLITZ INTERNATIONAL, INC. FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1999
AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<CIK> 0000856529
<NAME> Berlitz International, Inc.
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