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Lionbridge Technologies, Inc. (LIOX)

Q4 2009 Earnings Call Transcript

February 10, 2010 9:00 am ET

Executives

Sara Buda – VP, IR and Corporate Development

Rory Cowan – Chairman and CEO

Don Muir – CFO

Analysts

Joe Vafi – Jefferies & Co.

Rich Baldry – Canaccord Adams

Kevin Liu – B. Riley & Company

Joshua Horowitz [ph]

Bart Faber [ph] – Faber Capital [ph]

Bob Sail [ph]

Ali Motamed – Robeco Boston Partners

Operator

I’d like to thank all participants for holding. All lines will be on listen-only until the question-and-answer portion of today’s conference. (Operator instructions) I’d also like to inform the participants today's call is being recorded. I'm now turning the call over to Sara Buda, Vice President, Investor Relations. Thank you. You may begin.

Sara Buda

Thank you. And welcome, everybody, to the Lionbridge investor call to discuss financial results for the fourth quarter and fiscal year 2009. During this call, we may make certain statements that may be considered forward-looking statements under the Federal Securities laws and which involve risks and uncertainties.

Our actual future results may differ significantly from the matters discussed in any forward-looking statements. We have disclosed in greater detail in our Form-10-K filed with the Securities and Exchange Commission on March 13, 2009 and in subsequent filings the factors that may cause such differences.

And now I’ll turn the call over to Lionbridge Chairman and CEO, Rory Cowan.

Rory Cowan

Thank you, Sara. Welcome, everyone. Today I will walk through our fourth quarter and our 2009 results and discuss the recent accomplishments that really position us for a strong 2010. Then as is our custom, I’ll turn it over to Don who can walk you through some of the financial accomplishments and expectations for the coming year.

As you can see, it was a very strong quarter. Fourth quarter marked a very strong finish to a challenging year. We grew revenue both sequentially and year-on-year and delivered well above expectations in Q4. We accelerated our profits. We generated over $11 million in cash. We paid down $7 million in debt during the quarter. And this really resulted in returning the business to a net cash position. This is the first time since the BGS acquisition over four years ago.

Let me provide a few details on the Q4 trends, the milestones that give us confidence as we enter 2010. First, revenue for Q4 was about $105 million. Revenue grew by more than $7 million sequentially from Q3. And then in the last call and in recent investor conferences, I mentioned that many of our large clients were releasing new products, but we saw that that action is now beginning to return. That’s just what we saw in Q4.

After severe tightening earlier in the year, our tech and consumer clients finally began new product releases. In fact, our top 10 customers are up over 8% from Q3. Most importantly, the $7 million of sequential quarter revenue drove about $5 million of adjusted earnings or about $0.09 a share. So the incremental revenue fell right to the bottom line. Once again, this demonstrates the profitability potential of our business and the actions that are beginning -- and all the cost actions that we took are now beginning to bear fruit.

On a year-on-year basis, that is Q4 ’09 to Q4 ’08, revenue increased slightly. This is another positive milestone. After more than four quarters of year-on-year revenue declines, it is encouraging to see business return. Gross margins were about 33.5% in Q4, and that’s an improvement of about 240 basis points from Q3, and thanks to volume, of course, and positive work mix. This gross profit conversion and our ongoing cost management drove an operating margin of about 5%, that’s ex-restructuring of course in Q4. We are starting to see early indications of the underlying profit leverage that we all expect from this business.

We delivered adjusted earnings of about $0.12 a share in Q4, again a solid improvement, both sequential, quarter and year-on-year. As we said in the release, this is a preliminary estimate of GAAP earnings. We are taking a few extra weeks to complete our tax provision as there may be some favorable adjustments to tax, and we will update you on any favorable adjustments, if any, when we file our 10-K, and Don will have a little bit more to say about that.

We had another strong quarter of cash flow. We generated cash flow from operations of almost $12 million in the quarter. We paid down another $7 million of debt in Q4. And in fact, throughout 2009, we paid down about $31 million of debt. More importantly, we ended the year in a net cash position. So our balance sheet continues to strengthen, and Don will detail the aspects of that shortly.

So Q4 really proves the profit potential of the business and indicates our solid momentum as we enter 2010. So in addition to our accomplishments in the fourth quarter, we’ve got positive to share about our performance for the full year as well. We had a number of significant milestones in 2009. We delivered about $0.20 a share of adjusted earnings. In fact, despite a 16% revenue decline, we were able to increase our adjusted operating income. We generated $22 million of cash during the year. We paid down $31 million in debt. And as I said, we are now net cash positive.

These achievements are noteworthy in any year, but our accomplishments I think are -- I'm more proud of them this year given that we weathered one of the worst economic downturns in recent history. And that’s really because we’ve nurtured strong recurring relationships with our blue chip clients, we have an increasingly efficient model of technology and offshore execution, and we continued to generate cash. These business fundamentals allowed us to strengthen our performance in 2009 despite end market turmoil.

Now let’s talk about 2010. We have really three priorities for the year that should enable us to further accelerate our profit model. The first of course is revenue growth. It seems as if our customers are beginning to buy again. Last year it was pretty clear that no one was buying, so we didn’t do much selling. This year there is a fair amount of buying going on. So I think you’re going to see us ratchet up our focus on our sales organization.

We have made some changes. And first is a vertical market expansion, and we are also looking for multi-year commitments from our customers. And this new focus -- this twin new focus is already driving results. We are expanding new vertical markets. Our revenue in life science and pharma is accelerating nicely. We won several new clients in the manufacturing areas, including Rolls Royce and Caterpillar. We have the subject matter expertise in the delivery model in place to address the unique needs of these target markets.

As a result, we expect to accelerate these verticals in 2010. And we are also seeing an expansion of the size and duration of our contracts across all market segments. In fact, most of our new wins or recent wins have come in the form of multi-year commitments rather than individual projects. This is something we were working for, for a couple of years, and it’s beginning to happen. This is very positive and marks a strong transformation in the core language business.

And if you remember, our customers generate more than half the revenue from outside of the United States. They have to spend on language to sustain and grow the international customer base, and that is our business. As the market leader for the unique position to help these clients centralize and consolidate their language procurement processes to reduce their ongoing costs. This is the model for which we built our technology, and as a result, we are continuing to see our pipeline grow with multi-year contracts focused on this full outsourcing model. That’s our first priority.

Our second priority for 2010 is to complete our restructuring program. We are already seeing the benefits of our cost actions to date, as we mentioned. We’ve reduced our SG&A cost by about $19 million year-on-year, and we expect to continue our cost actions over the next few quarters. As I’ve said, by being thoughtful about our restructuring, it’s costing us less and we are strengthening our customer relationships as we move them to other facilities.

So we expect this to be largely complete by the end of Q3. Some of that may dribble into Q4, but that feels as Q3 is a good target for now. These cost actions allow us to manage our overhead and mitigate some of the negative effects of currency. As it’s unclear which way currency will go in 2010, we get weekly forecast here from major money center banks, and there is a great variation in their forecast for Q4. So I think no one knows where the dollar is headed. I do know though our goal is to configure our model, so we are less currency sensitive.

So our -- Q4, our cost management is really enabling us to drive significant profits on incremental revenue growth despite the currency headwind that we saw during the quarter. So cost reduction remains a priority of 2010 that allows us to address the underlying cost of the currency exposure.

So our third priority for 2010 is really our technology. As you may recall, late October we announced Translation Workspace, the industry’s first and only SaaS platform for translation. This is based on our proven Logoport technology, which has been in production for many years internally and has thousands of users. In fact, we believe our platform is the single largest repository of commercial translation memory in the --commercial translation memory data in the world.

Over the past 12 to 18 months, we have transformed this proven technology into a secure multi-tenant platform for translators and agencies in over 100 countries. I think that’s really been the -- the core of the development work is to really allow this technology to go live concurrently in 100 countries in a secure multi-tenant architecture. So we believe that we will now offer the world’s leading translation services and become the world’s leading cloud-based translation technology as well.

This should allow us to expand our market opportunities and drive highly profitable revenue as we grow our subscriber base over time. With our refined operating model and our plans for cost reduction identified, we are able to accelerate our language technology investment and leadership.

So in summary, 2010 promises to be a good year. Growth is returning. We continue to reduce our costs. Technology is accelerating. And as a result, we enter the year with a linear operating model, stronger revenue pipelines, and new opportunities for market expansion. So all of this indicates that it should be a positive year for increased growth and profitability.

So Don, over to you.

Don Muir

Thank you, Rory. Hello, everyone. As you can see from the release, we had a very strong finish to 2009. So I’ll start with a review of the quarter and year, and talk about our continued success in the areas of cash flow and debt reduction. Our financial achievements of the fourth quarter include revenue of $105 million for the quarter. This marks a sequential increase of $7 million from Q3 and an increase of about $400,000 from a year ago. We are delighted to see growth return to the business. Much of that growth was from our top accounts like Microsoft and HP, tech clients with strong product recycles during the quarter.

Fourth quarter gross margin was 33.5%. Margins in our GLC language business were 34.1%, the highest in about ten quarters due to positive work mix and higher revenue volumes. Income from operations was $5.7 million, ex restructuring, again a strong sequential improvement from Q3 and year-on-year. In fact, year-on-year we actually increased our operating profit by over $2 million, excluding one-time items, on only about $400,000 of incremental revenue growth. This reflects the benefits of our cost actions and our efficient technology model.

For the quarter, we had a preliminary tax provision of $750,000. This tax provision estimate excludes any impact of potentially favorable tax provision adjustments, which are currently under review. We expect to finalize our tax provision calculation and income tax related balance sheet accounts over the next few weeks and certainly by March 16th when we plan to file our 2009 10-K.

Now back to the fourth quarter results. We returned to GAAP profitability with preliminary net income of $0.03 per share. We generated $11.7 million in cash flow. We paid down another $7 million of debt, and we ended the year with a net cash position of $2.7 million. So our balance sheet continues to be in great shape and we are delighted to be net cash positive for the first time in over four years.

Now let me get into the details of the full year. For 2009, we generated revenue of $389.3 million. This is a decrease of 16% year-over-year largely due to currency and the global economic slowdown. However, despite this revenue decline, we increased net income, excluding restructuring, by $0.03 per share. Our ability to strengthen profits in such a difficult economic environment speaks volumes about the underlying profitability model of our business.

Gross margin for the year was 32.2%. This marks an increase of 30 basis points from last year despite the volume decline. Margin on core GLC language business was 32.3% for the year, 150 basis points higher than 2008. This is the result of our diligent cost reduction actions and the benefits of our technology enabled [ph] production model.

Margins in our GDT business were 35.1% for the year, a decrease of 250 basis points due to lower volume and the ramp-up of some new accounts. During fiscal 2009, we significantly reduced our operating expenses. In fact, our operating expenses are down by $22.7 million year-on-year, excluding restructuring. Most of this reduction is in our SG&A line, as we continue to reduce our overhead cost, specifically in Western Europe.

As a reminder, for those of you who are new to Lionbridge story, about 50% of our revenue is in non-USD, but about two-thirds of our cost are non-USD. By reducing cost in target locals, we can strengthen our operating model and minimize our currency exposure. So as you can see from our strong second half in 2009, our diligent and focused cost management is paying off. For the year, we have a preliminary tax provision of $346,000.

On a GAAP basis, we had a preliminary loss for the year of $4.5 million or $0.08 per share. Excluding restructuring expenses, we were profitable by $0.04 per share. We delivered preliminary adjusted earnings for the year of $0.20 per share. Our adjusted earnings exclude restructuring, stock-based comp, acquisition-related intangibles, and certain one-time items. You can see a reconciliation of our adjusted earnings to GAAP at the end of our press release.

So 2009 was a strong year, particularly in the face of a challenging economic environment. We improved our gross margin percentages. We reduced our operating expenses. We increased income ex restructuring. We returned the business to adjusted profitability, and we finished the year with strong revenue growth and profit conversion.

Moving to the balance sheet, our liquidity position remains strong. We generated more than $22 million in cash flow from operations in 2009, and that is after funding restructuring. And we paid down more than $31 million of our debt. Our year-end bank debt is now $24.7 million, and we ended the year with over $27 million in cash. As we said, that leaves us with a net cash position of $2.7 million. So I am delighted with our cash flow, liquidity, and in particular, our working capital management in a challenging macroeconomic environment.

DSOs are down to 48 days, a reduction of 10 days from 2008. And our global teams have done a terrific job, delivering high quality services that add clients value. And we have clearly maintained our focus on working capital management fundamentals. This has enabled us to deliver very strong cash flows in 2009 despite the adverse market conditions.

In sum, our financial performance in the fourth quarter and full year 2009 was quite positive. Revenue growth is beginning to return. We are reducing costs. Margin and profits are improving. We continue to generate cash. And we are net cash positive. So in summary, as Rory said, in 2010, our teams will be focused on three things. One, accelerating revenue growth; two, optimizing the business model for profitability by restructuring our high-cost locales; and three, advancing our language technology to open new market opportunities. And we are on very solid financial footing as we look ahead into 2010.

We ended the year with strong revenue and the pipeline of business feels solid. We are proving that the business model can drive profitability. Incremental revenue is converting [ph] into strong bottom line profits. Cash flows remain strong. And we expect to generate cash for the full year in 2010 as we deliver positive net income. Typically we consume cash in Q1 and then accelerate our cash flows throughout the year.

Our P&L outlook for Q1 in 2010 is positive. For Q1, we expect revenue of $95 million to $100 million. This is in line with our traditional Q1 seasonality and the assumption of a sequentially weaker euro compared to Q4. Gross margin may be a bit lower than Q4 levels on lower volume and change in work mix. But operating expenses should be down sequentially as a result of cost reduction and currency. So all in all, we expect a solid start to the year, and we expect that revenue will accelerate sequentially in the second quarter.

For 2010, we are reiterating our estimate of revenue growth of between 5% and 10%. Gross margin and operating margin should improve from total year 2009 levels, assuming today’s currency environment. As I’ve said, we expect our tax provision to be about $750,000 to $1 million per quarter. With solid revenue growth, the benefits of our cost actions and a currency tailwind, we should see significant earnings acceleration in 2010.

So in summary, we had a solid finish to 2009, and 2010 is looking even stronger. I look forward to the New Year. Rory, back to you.

Rory Cowan

Thanks, Don. I guess in sum, as Don mentioned, we had a number of good milestones in 2009 despite that tough beginning to the year. We increased our adjusted operating income despite a 16% revenue decline year-on-year. We returned the business to profitability, ex restructuring. We generated about $22 million of cash during the year and paid down about $31 million in debt. We ended the year with a net cash position. The business is growing again. And of course, in Q4, we saw our incremental revenue growth would drive strong profit conversion.

So I guess with a strong cash position, lower fixed expenses, firming demand, and technology leadership, we should have a strong 2010 and 2011. I’ve been through this cycle before that’s part of other business cycles. And it feels as if there is quite a lot of interest among customers now, and now I think it’s just a question of getting these programs and projects closed and getting the files and the relationships initiated.

So with that, I’ll open the call up to questions.

Question-and-Answer Session

Operator

(Operator instructions) And our first question comes from Joe Vafi. Your line is open.

Joe Vafi – Jefferies & Co.

Hi, good morning. Nice to see some strong results here.

Rory Cowan

Thanks, Joe.

Joe Vafi – Jefferies & Co.

Just a couple quick ones. One, I guess, Rory, you mentioned that your top customers grew at I think an 8% sequential rate in Q4. Is that what I heard correctly?

Rory Cowan

That’s right, yes.

Joe Vafi – Jefferies & Co.

How are we looking at that top group of customers relative to that Q3 to Q4 growth? Was that -- are you still seeing those volumes increase from those customers kind of despite the seasonal trend that we usually see in Q1, or was that kind of a fully ramped kind of surge that we saw from Q3 to Q4 at this point and we’ve got to kind of wait now for some new products and new projects from those customers to kick in to see growth from here?

Rory Cowan

Yes. I think that’s a great question. Again, at this phase of the recovery, I was concerned, as I think I mentioned when we were on the road and I think at the recent conference that we spoke that one of my concerns was what if this budget burned and people steal from Q1, or was this just a burst of products. Many of our large customers do have strong product plans for 2010. As you know, the way our model works is that I sort of think of us as being a sign wave with an upward slope. And we get more relationships and then the product life cycles of each client tend to sort of cancel or build on one another. So I think during Q1, we do have mentioned some strong new wins. That’s really a question of when those get into the system. We always find in Q1 of course that budgets aren’t released in really till week-three or week-four of the quarter. And so we are now just getting a clear beat on what the quarter looks like. Having said that, I think Q2 through Q4 you are definitely going to see some very real strengthening in the year.

Joe Vafi – Jefferies & Co.

Okay. That’s helpful. So it wasn’t really -- you wouldn’t call it flush in Q4 then? Would you call it flush potential?

Rory Cowan

No, I wouldn’t call it flushing out the pipeline at all. I think that there were a large number of -- one of the nice things about our company is that about ten -- our top ten customers are over half of our revenue. They are world-class names. So we have no payment issues. And so just we have been dealing with the number of their various dimensions of -- various product divisions, sorry. So it really just depends on their cycles. I don’t think it’s a flush by any means.

Joe Vafi – Jefferies & Co.

Okay. Fair enough. And then maybe if kind of look at Lionbridge over the last couple of years, we’ve always had these big customers, but I know you mentioned that you are starting to get more -- maybe more multi-year contracts in place. Does that change at all the kind of visibility profile that you have with your customers as we kind of look forward relative to what maybe we’ve seen in the past?

Rory Cowan

No. That’s a great question and discussion that we have at our Board meetings all the time. This gives us a -- I guess I would say there is not Vaseline on the glass lens -- on the lenses, but it’s a little clearer now. But we are still dependent on customers’ product cycles. So even if we have a multi-year contract that we might say where the sole source for a particular company or a particular division, we are still a little bit at the vim of their product release cycles.

Joe Vafi – Jefferies & Co.

Okay, fair enough. And then just one quick housekeeping one for Don, tax rate that we should be thinking about in 2010?

Don Muir

Well, again, Joe, I think we’ve given some guidance that really tries to quantify our tax provision in dollars in a range of $750,000 to $1 million. I think we said that long-term we’d be pointing to a tax rate that certainly should be below 25% on an effective rate.

Joe Vafi – Jefferies & Co.

Okay. Thanks a lot. Good results.

Don Muir

Thank you.

Rory Cowan

Thanks, Joe.

Operator

Our next question comes from Rich Baldry. Please state your company name.

Rich Baldry – Canaccord Adams

Thanks. It’s Canaccord. Could you maybe talk about what it would take as a macro backdrop to get back to sort of your former highs for revenue? If you look in the ’08, you had an ability to somewhere in the $115 million to $125 million. And subsequent that, you’ve announced a lot of strong new customer wins that presumably could drive that higher. So what would it take to get back to that, maybe placing that against the backdrop that in ’02 in a macro-recovery you saw pretty sharp sequential upturns in the middle of the year that I think took you and a lot of people by surprise in that recovery scenario? Thanks.

Rory Cowan

I guess you got a couple of questions embedded in that one question. First, during the recovery phase, it is sort of fits and starts. Maybe two steps forward, one step back. And it feels as if we are entering that phase right now. I will say when talking with our customers there is a firmness and a -- what I say, a maturity now at this cycle and a confidence that we didn’t feel before. Now I will believe that once I actually see the files and see their programs and really get actual budgets and work plans for the release of these projects. So what does it take to get us stronger than I think our current outlook is? Couple of key customers are really living up to their commitments and living up to their own internal plans more than anything else. We also have a couple of new customers in the pipeline, which we hope we’d be able to announce by mid-year, which should also add to this. And these two are world-class names and global brands.

Rich Baldry – Canaccord Adams

And then maybe could you talk about your cash usage priorities in 2010, whether they would be similar to ’09 with the focus on maybe an eliminating outright your debt position or if you look at something more on, say, an equity buyback type of thing now that you’ve turned net cash positive? Thanks.

Rory Cowan

Let me start this and I think Don could put a finer point on it. I think our real focus now, when you have a market that’s growing again, you really want to take advantage of that. So first, restructuring is first use of cash. Second, I do want to accelerate our technology investment. Third issue we have is any excess cash of course could probably pay down debt, but I think that’s very manageable number right now. And I don’t really see us moving into stock buyback until we are further along into the recovery in a more stable economy. So I think the opportunities for us right now are very strong. Lastly, we have seen a couple of our smaller regional competitors hit some very difficult financial times. And so there may be some opportunities for some small tuck-in acquisitions. We’ll never do another BGS. I don’t want to say never say never, but that one has been a very real struggle for us to get the operational under control as we’ve now done. But there are some opportunities for smaller acquisitions. So I think restructuring, technology, and a potential tuck-in acquisition, then debt paydown, and I think at the bottom of the list would be stock buyback, at this phase of the recovery.

Rich Baldry – Canaccord Adams

Thanks.

Rory Cowan

Anything to say? Anything to add?

Don Muir

I agree with those priorities, Rory.

Operator

Our next question comes from Kevin Liu. Your line is open. Please state your company name.

Kevin Liu – B. Riley & Company

B. Riley. Good morning, guys.

Rory Cowan

Hi, Kevin.

Kevin Liu – B. Riley & Company

First question here, just in terms of the vertical strategy, now obviously you’ve seen some strength in pharma and manufacturing, just wondering if there are any verticals where you haven’t seen that strength come back yet or where you think you might have a more difficult time in 2010?

Rory Cowan

Yes. I think that we are starting -- it's always a question of how you organize the go-to-market team. When people aren’t buying, you tend to go geographically. And when you start to see the world strengthen again, you really focus on verticals because it’s a little bit more expensive a model. We are focusing on those verticals to isolate, that being the manufacturing and life sciences, in addition to our normal traditional sort of worldwide wireless groups and our traditional consumer technology groups. Anything that we are seeing were isn’t coming back. Financial, three or four years ago, we had some strength in financial. I think that that group has cut back and so we are not putting as much energy behind that focus as we used to. But that may be, for example, the potential -- that may give us potential for a tuck-in acquisition, as there are a couple of these firms based one in London, one in New York, that really do focus on financial translation -- financial industry translation. But that may be the way you’d want to enter there. Patents might be another one. There are a couple of small players, accurately [ph] in Asia that focus just on patents. So I think for now it’s manufacturing, life sciences, and pharma, and then our general technology end markets. And you may see us refine that further as we enter 2011.

Kevin Liu – B. Riley & Company

Got it. And then any incremental update on the Translation Workspace offering? Just wondering if you guys have a better handle in terms of the pricing you’d like to offer now what sort of the initial lead generation activity has turned up.

Rory Cowan

That’s a good question. We didn’t really focus on that much in this call. And thanks for bringing that up. But we have general availability at the end of this quarter. We’ve been doing also [ph] weekly webinars in the industry, we’ve staffed up the marketing teams, we’ve got people focused on various segments from freelance translator to small agencies to enterprise here in the US. We are in the final beta of user acceptance testing. I would say that the challenge for that product is really the re-architecture to have a secure multi-tenant architecture because we are going to have thousands of private work spaces in that.

And secondly, making certain that it can go live in 100 countries concurrently. So the commercial [ph] wrapper and the re-architecture of the underlying technologies have taken most of the development time. Early indications are we’ve done some test results. People like the product. Remember, many many of our translators have been using that product for four or five years will now be able to subscribe to it for work that they do not perform for us, because an individual translator in our survey suggest they work for anywhere from three to five agencies around the world. This will allow them to be more productive with their other customers. So we’ll let you know. And I think my bet is it’s going to be more like the end of Q3 when we’ll start talking about actual numbers, but I think we’ll have a little bit more color because we go live really at the end of this quarter.

Kevin Liu – B. Riley & Company

Okay. And then last one, Don, I’m sorry if I missed this in your guidance comments earlier, but just wondering kind of what the restructuring assumptions as well as the other income related to forex lines would look like for Q1 in 2010?

Don Muir

I think that you should expect kind of the $1.5 million to $2.0 million a quarter of type of restructuring number that we’ve experienced I think in 2009 and during 2010. And as we said, the FX impact that you see to the other expense line is probably around $500,000 a quarter is what we’ve experienced. And that -- I think that’s what I would use for your models.

Kevin Liu – B. Riley & Company

Great. Thanks.

Operator

Our next question comes from Joshua Horowitz [ph]. Please state your company name.

Joshua Horowitz

Hi, private investor. Great quarter, guys.

Rory Cowan

Thanks.

Joshua Horowitz

Tremendous job. Couple of questions. Is there a specific dollar amount targeted for the 2010 cost reductions? And I guess to go along with that, when is the restructuring plan table to be complete?

Don Muir

Well, I think, Josh, if you recall initially last year when we first announced our restructuring program, we had targeted an $18 million to $20 million overall expense reduction. And I think that we’ve -- we've already put a big dent into that, but we do have some more restructuring to go. So I think we probably may even exceed that number in total. I’ve got cost actions that we’ve taken. But I think as Rory alluded to in the call, we’re hoping to get most of this restructuring behind us by the end of the third quarter of 2010.

Rory Cowan

You may see a couple million dollars a quarter for Q1, Q2, and Q3, and then some things trail off into Q4. But that’s the current plan that we have. And adjusting for any models that you’re doing, we get anywhere from sort of a nine-month to one year payback on that. So that’s what we’re beginning to feel. In fact, I think that’s what we saw in Q4.

Joshua Horowitz

Great. Another question for you. We used to worry a lot about the rising euro, now obviously that’s gone the other way. Without asking you to make a currency prediction or outlook, maybe you could just more specifically walk through the hedging program and some of the changes that you foresee having to make to that program this year is indeed it’s an environment where there is increased pressure on the euro.

Don Muir

John, I think as we commented during the call, the best way that we see to manage currency is by reducing the absolute dollar volume of our expenses denominated in euros primarily in Western Europe. And that’s the focus of our restructuring and our cost reduction efforts. We don’t really hedge the foreign currencies per se. So that’s -- it's not really going to be a change to our hedging program. It’s just a reduction in the absolute dollar volume of these foreign currencies.

Rory Cowan

And I think, Josh -- this is Rory. Remember, last year at this time, where were we? We are like in 120s or low 130s, and then the euro bounced back up to close the year in mid-140s. And as we have seen at our banks, we have a similar breadth of forecast for the second half of this year. So rather than compete with (inaudible) in the currency markets, I think we’ve just decided to really attack the disease, which is to minimize exposure in Europe and so we can have more of a natural hedge in the business.

Joshua Horowitz

I agree with that strategy and I support that. I guess one more final question, this is more from I guess the outlook of the business three, four, five years from now, have you given any thought to or analyze the licensing potential of the tremendous amount of database work and translation memories, and how that would look outside of the traditional customer contract, in essence selling the people access one word at a time, and when we can see that as a more substantial part of the revenue line in the future.

Rory Cowan

Josh, your intuition is absolutely a spot on. There are a couple of issues. I think if you really want to look at our technology strategy, it was first, prove the technology for internal operations; then it’s build the commercial accessibility wrapper of this in the web-based availability and metering wrapper. That’s really what this year is all about, get people on. Then we can begin to offer. Once we have that offer, additional capabilities through this global commercial infrastructure we’ve built. So for example, we have some unique linguistic quality tools, which we could offer to people on an individual basis or is it $3, is it $5, is it $10 a month. On top of that, there are some unique automated translation technology that could be tuned or trained by domain, by language that could be offered on $6, $8, $10, $9 a month, whatever the number might be. So your intuition mirrors our strategy exactly.

Joshua Horowitz

And am I right to say that these potential sources of revenue are currently carried on the balance sheet at close to zero?

Rory Cowan

Yes, we basically have because we’ve got very little -- we've got some capitalization of our software because of course you’re required to, but it’s minor. It’s --

Don Muir

Yes, we probably capitalized $2 million a year in internal and external software development activities.

Joshua Horowitz

Very good. Well, thank you for your thorough and honest answers. I appreciate it.

Rory Cowan

Great. Thanks.

Operator

Next question is from Bart Faber [ph]. Please state your company name.

Bart Faber – Faber Capital

Faber Capital [ph].

Rory Cowan

Hi, Bart.

Bart Faber – Faber Capital

Nice quarter. Hi, Rory. Nice quarter, you guys. I love the cash generation. It’s always the bottom line, isn’t it?

Rory Cowan

Well, cash, it’s -- cash only keeps the payroll going. So --

Bart Faber – Faber Capital

That’s right. Most of my questions have been answered. But what do you think the actual growth rate in this business is over an extended period of time? I know we’ve had a terrific dip here the last couple of years. But is this a 3% growth business or a 5% or 10% growth industry? Are you planning on taking share or just keeping upward share?

Rory Cowan

I think you really have -- that’s -- we've spent a lot of time analyzing the industry this year. And there are really three unique segments to the business. There is a very high end group, which is the large consumer products, where we have generally focused. And then the SMEs, the small and medium enterprises, they are probably growing a little bit faster, but of course they have a higher cost to acquire in customer acquisition cost. And then of course you have $2 million to $4 million of the small local translation business. So that’s the industry structure.

Then layering on top of that, you will have a sort of pricing model, which I think we are finding is that as we can automate more and if we take our technology to focus more on that middle market, you may be able to have a good enough offering that is more highly automated which would accelerate our growth, because of course there are lots of areas where it’s just too expensive to professionally translate every FAQ on a technical support site, for example. But if you take our technology, trained with our professional translated content, you may be able to bring that in at a different price point. So each of those segments has a different growth rate, and each of those applications will have a different growth rate. On balance, we’ve heard anything from a -- it's a 5% to 12% industry grower worldwide, very hard. This is a $10 billion to $12 billion business worldwide, so very very hard to focus on actual growth rates.

Bart Faber – Faber Capital

Okay. Thanks, Rory.

Rory Cowan

Thanks, Bart.

Operator

Our next question comes from Bob Sail [ph]. Please state your company name.

Bob Sail

Hi. Congratulations on the quarter again. I thought the euro would give you guys a little more of a problem given the rise in Q4. On that note, the euro has gone from -- it looked to me like it was in the mid-140 through Q4 and now it’s significantly lower. Given the state of your overhead cost reductions in Europe, can you give us a sense of quantifying the benefit given that kind of drop?

Rory Cowan

Yes. I think if you think about the comment I made in the conference call, if you look at revenues, which are roughly denominated, 50/50 USD and non-USD, with the non-USD portion predominantly Europe, and you look at our operating expenses, which tend to run about two-thirds non-USD to USD, at the gross margin line from a dollar standpoint, it’s pretty close to a wash. So if currency moves one way or another, it doesn’t necessarily hurt us to (inaudible) may influence the gross margin percentage a little bit. But the dollars don’t change a whole lot where the leverage is in the operating expense line. So what we typically tell people is that if the euro moves a penny over the course of a year, it’s probably about $0.5 million impact one way or the other in terms of operating profit, that’s primarily given the change in the operating expense levels that you see. So certainly if you look at the euro weakening, that tends to reduce our expenses and it will certainly help us. It may give us a bit of a headwind on the top line. But overall to P&L it’s benefit.

Bob Sail

Don, what do you have down as the average euro for Q4?

Don Muir

I think it’s up close to 148, 149 type of range.

Bob Sail

148. We are at 137 right now. Okay.

Don Muir

Yes.

Rory Cowan

Yes. And remember there is a bit of a lead in the lag because I have a lot of POs on the street with translators. We have a lot of customer POs coming in. So this isn’t -- everyday it falters its ratios, we get a benefit or a headwind. So there really is about a six or eight-week lag in the process here. So we are still probably flushing through a lot of Q1 words -- Q4 words during Q1. And I’d add, instead of a dynamic environment, we do business in probably about 15 different currencies. It’s difficult to gauge which way those currencies move against the euro and the dollar. I think in Q4 you may have seen some currencies that typically move with the euro against the dollar, move sideways against the euro. So it’s a very dynamic currency environment. And as I said, the best way that we believe we can manage the currency exposure is by reducing those foreign denominated expenses in absolute terms.

Bob Sail

Great. Okay. And then one last question and (inaudible) but it’s been a big challenge for you guys. At the end of your restructuring plan, where do you -- given the revenue would still be likely 50/50 US dollars to other FX, where do you expect the overhead to be in terms of US dollars versus other currencies if it’s two-thirds right now non-US currencies -- non-US dollars?

Rory Cowan

We’re still going to have -- most of our operating expenses will be offshore, denominated in one foreign currency. We have another one that’s an Eastern European currency, Chinese renminbi or the rupee. So we’re still going to have some of that currency exposure. What hopefully won’t be quite as volatile as what we’ve experienced with the euro, but we’re going to continue to manage that exposure as best we can, matching the revenues and the expenses as best we can so we have some natural hedges. But we expect the euro exposure to be decreased once we finish this restructuring program. We’ll probably take out another, as Rory said, for $6 million, $8 million in absolute terms this year.

Bob Sail

Okay. Thank you. And congratulations again on the quarter and the outlook.

Rory Cowan

Great. Thank you.

Operator

(Operator instructions) And our next question does come from Ali Motamed. Please state your company name.

Ali Motamed – Robeco Boston Partners

Hi. Robeco Boston Partners. Great quarter, guys.

Rory Cowan

Thank you.

Ali Motamed – Robeco Boston Partners

I was wondering -- two quick questions. First of all, how big are the top ten clients you said that they grew 8%, how much of that 7% growth was that accounting for, 8% sequentially?

Rory Cowan

Hi. (inaudible) 8% sequential -- top customers grew 8% sequentially. So you want to understand of our growth, how much of the growth were top customers.

Ali Motamed – Robeco Boston Partners

Yes.

Rory Cowan

Probably the majority -- I don’t have that map in front of me. That’s a great question. But the two big growers, as you know, Microsoft is entering a very strong product release cycle and we are very strong with all parts of Microsoft. And in addition, Canon was another one that was very strong in Japan. Lastly, our HP relationship, HP’s procurement group really get their arms around their supply chain there. I think HP is a company that’s really showing great, great discipline in consolidation. We saw a fair amount of growth with HP as well.

Ali Motamed – Robeco Boston Partners

So how big are the top ten as a percent of total sales? How about that?

Rory Cowan

Top ten for total sales is just little over 55%.

Ali Motamed – Robeco Boston Partners

Okay. And then what about for next year, as lot of the growth, where would you say it’s coming from, existing or new customers?

Rory Cowan

I think you will see a little cycle of both. I am not hedging here, but I am hedging in it. Although we have product cycles with our large customers, that’s a question, for example, Canada had a good year in 2009. You probably won’t see much from them until the end of 2010 and maybe turning into 2011. But we do have a number of new large customers that have committed to us to fill that gap that Canon leave. So I think the top ten, they should be about half our growth. The new customers, that should be the other half.

Ali Motamed – Robeco Boston Partners

Okay. And then the last question would be, you said you’re going to increase discretionary SG&A because you see that -- or selling expenses because you see the market strengthening. How much have you sort of quantified? How much you want to spend?

Rory Cowan

I think we’re going to just loosen up a little bit here. Is it going to be another $1 million year-on-year, maybe $1.5 million, somewhere in that range, because we have that group buttoned down pretty tightly. I may push it to two depending upon the caliber of sales people. I --

Ali Motamed – Robeco Boston Partners

And that’s for the whole year?

Rory Cowan

Yes, for the whole year.

Ali Motamed – Robeco Boston Partners

Okay. All right. Thank you very much.

Rory Cowan

Great. Thanks an awful lot [ph].

Operator

At this time, I have no further questions.

Rory Cowan

Great, everybody. Thanks very much. I look forward to talking to you at following Q1. As always, if you have any questions, please route them to Sara Buda and she can track it Don and me down for the rest of the week. Thanks a lot.

Operator

That does conclude the call today. You may now disconnect at this time.

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Source: Lionbridge Technologies, Inc. Q4 2009 Earnings Call Transcript
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