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Executives

Rory Cowan - Founder, Chairman, Chief Executive Officer and President

Donald Muir - Chief Financial Officer, Principal Accounting Officer and Senior VP

Sara Buda – Investor Relations

Analysts

Brian Kinstlinger - Sidoti & Company

Randy Hugen - Piper Jaffray

Mat McCormack – FBR

Marty Wales - UBS

Joseph Vafi - Jefferies & Co

Mark Cooper – Wells Capital

Lionbridge Technologies, Inc (LIOX) F1Q08 Earnings Call May 6, 2008 9:00 AM ET

Operator

Good morning and thank you for standing by. All lines will be in a listen-only mode until the questions-and-answer session. (Operator Instructions) Today’s conference is being recorded. If anyone has any objections you may disconnect at this time. Now I will turn the meeting over to Ms. Sara Buda; you may begin.

Sara Buda

Thanks. Welcome everybody; welcome to the Lionbridge Investor Call to discuss financial results for the first quarter of 2008. During this call we may make certain statements that may be considered forward-looking statements under federal securities laws and which involves risks and uncertainties. Our actual future results may differ significantly from the matters discussed in any forward-looking statements. They are disclosed in greater detail in our Form-10K filed with the Securities and Exchange Commission on March 14, 2008; the factors that may cause such differences and now I will turn the call over to Lionbridge Chairman and CEO Rory Cowan.

Rory Cowan

Well, thank you Sara. Welcome everybody and today we will walk you through Q1 of course and discuss the priorities and outlook for the rest of the year. Q1 was clearly just a workman like quarter; revenues were up, cash was up, cost and currency expenses were down and the pipeline is up and this quarter obviously was all about currency and as we know it’s no surprise, it was a very tough quarter.

The dollar decreased more than 16% year-on-year versus the euro and that we estimate that this costs us almost $0.09 a share, this quarter alone on the P&L despite the revenue benefit and of course a lot of these are non-cash expenses because we are revaluing inter core -- our balances, but none the less on a GAAP basis it is about $0.09. That’s a little hard of course when you have currency volatility because it’s just point-to-point; you’re picking two particular times to calculate the math and when you are in a stable currency that’s not a problem but when you have 16% year-on-year and almost 9% within the quarter it’s a little bit challenging to really do your books.

It’s isn’t just the weaker dollar; we can manage through this with cost reduction and hedging which I think Donald will share with you. We have done some great, great efforts in this area. As I said it’s that volatility during the quarter that causes the challenge.

We ended the quarter with $1.45 euro and less with the euro we are about $1.59 and up to 9% increase after huge volatility within the quarter. As you know about half of our revenue is non-US dollar but about 75% of our cost of sales is outside of the US and more than 60% of our G&A is outside of the US, so we are on the long side of this trade and with this mix you could imagine if the headwind -- if their rates move so quickly and dramatically in such a short time.

The currency volatility of course continued with the euro peaking at about $1.60 in April but in spite of today’s activities the euro is trending down and as I am certain you have all seen all major financial institutions are predicting the euro in the 1.40’s in the second half in the year. The highest we have seen is $1.50, we have even seen as low as $1.30’s, so it looks as though things are peaking and this headwind should become a tailwind in the second half of the year and early next year.

So we are optimistic that all of the cost management we have been going through should really begin to give us some increased leverage in the second half of the year. None the less we don’t want to wait for the two tier here, so we are continuing to implement some increased cost management programs to further offset euro exposure and we will detail this as we go throughout the call, but despite the currency noise our operations are coming together very well.

Currency adjusted gross margin and operating income improved over last year and our organic revenue growth is strengthening. For the quick summary for Q1 we saw a number of really positive trends; first solid top line growth, about 8% year-on-year. Well, clearly a lot of this was currency related. We ended the quarter with a very strong March and we are really focusing more on gross margin dollars here now rather than just straight revenue growth. We have a growing pipeline which indicates a positive momentum for the second quarter and for the full year, so our mid quarter ramp seems to be building very nicely.

Second, on a currency adjusted basis, gross margins would have been about 33.6, so margins are returning to prior level. All of last years work is beginning to show through in a cost and currency basis and cost management benefits. As you know we reconfigured two offices in Q4 and excluding currency we would have seen an improvement by almost $1 million from last quarter; sequential quarter $1 million of operating income ex-restructuring. So, we are benefiting from the past cost reduction actions and we have more planned which I will detail shortly.

Fourth and finally in the quick summary here, cash balance remains very strong. While we consumed cash during the quarter as we usually do, our cash balance remains healthy at about $26 million and this is after spending $2.3 million to buy back some stock during the quarter and as I said we can run this business with about $18 million to $20 million in cash; we have plenty of head room here and historically cash flow from operations improves steadily throughout the year.

Overall for the quarter we drove good revenue and we strengthened our operating incomes despite currency. We expect to build in this positive momentum and grow cash flow as we head into the seasonal mid year ramp.

Now lets talk about a few of the trends that give us the confidence for the second half of the year and the rest of the year impact. First, revenue; it’s a broad demand across all of our business. We grew many of our existing accounts and secured new business with companies such as manufacturing.com, Global Online Market Place for the manufacturing community.

We are also seeing new wins in Europe. Of course, the goal here is to get European revenue with European expenses, so you have more of a natural hedge. Of this quarter we won large programs with the European airline and the Spanish railway. So we are increasing our focus on European revenue and this euro as we call with short hand year revenue growth is a positive trend, particularly in this currency environment and these projects should begin to ramp throughout the year.

They also saw some very good new from us about a new program with the Microsoft dynamics group; this is the Microsoft’s ERP group and this program was significant for two reasons; not only is it a good book of business but first they selected us to be a majority supplier there because of our logo port technology and our program management capability; again this technology and managed service idea that we are talking about. This will ask the client to redeploy a lot of their internal capacity to focus on additional activities and new markets.

Second we are really moving from being a vendor and to becoming a business partner for this group. In essence we are using our technology logo port to give the dynamics team their world wide partner’s access to Microsoft’s translation memory assets. In doing so we are reducing the cost and complexity of translation for these partners, many of whom didn’t localize their products in the past. So in this case we are becoming a channel partner for Microsoft and name in this division and their partners to sell more software in more global markets.

So this new channel partner strategy is not unique to the Microsoft group. In fact we are running a similar program for Lows, a home improvement company. We are hosting a lot of their TM’s and a lot of their suppliers and we have access to this and so we will be hosting their own multi-lingual database and we see opportunities with several other clients who are looking to expand their partner programs globally.

We are going to peruse this channel strategy, because of the unique nature of our hosted lines technology platform and this technology is giving us a competitive analysis with customers and enabling us to open new revenue streams. So everything we talked about last year is really beginning to get some traction here.

Clearly we are seeing positive revenue trends in our traditional business. We are also seeing strengths in our other segments. In particular we are growing our search relevancy testing business. This is for multilingual testing of search relevancy which is part of our GDT segment. This service offering builds on our ability to manage a worldwide contract workforce to translators and now we are applying this skill to global internet search. This is where we test the relevancy and usability of a given search term and a given geography. For client this service is very important because the information we provide helps them drive increased revenue through far more relevantly targeted global advertising. So, you can see the broader possibility of this service for a number of our existing and potential clients and you begin to see how this service builds on our skills of managing a global multilingual work force.

The other area we are seeing demand is global content. This includes areas such as e-learning, mobile content more than anything else and rich media conversion and these services enable us to utilize our offshore infrastructure. Our expertise in global content is enabling us to expand many of our existing account through the new business and in fact we have just expanded our new Chennai, India facility to meet this growing demand and I think that we should be moving. I think it’s a 700 or 800 seat facility that we should be occupying sometime during the coming month or so.

So, to summarize revenue we are seeing several positive indicators; strong March and continued acceleration into April, so the revenue ramp is building, strengthening our European revenue business. It serves us well from a revenue and margin stand point given the currency volatility and our core language business through various channels and complementing this growth with their other service offerings. We are feeling pretty good about that part of the world.

Now let’s talk about cost. We have got several initiatives in place to improve margin such as deploying our technology and moving more work offshore. These initiatives are on going and in fact to reduce SG&A during Q4 we reconfigured two officers. In Germany we consolidated one office with our other two offices in Germany and our New York facility of course we move to a virtual work force with a majority of that team working from home, linked in to our worldwide platform or technology. So this is of course reducing our head count in overhead areas and leases as well.

We can see the benefits of these actions; unfortunately the rapid currency movement -- I haven’t allowed these to come through to you guys yet but we clearly see the benefits of them and are quite excited about this new lighter G&A model. Given the currency environment we face today we have initiative several incremental actions to further manage our costs, even though banks are forecasting a strengthening dollar in H2 as is said it (inaudible) us to continue to manage cost regardless of the currency relationships.

First we are working at customers to offset some of this currency impact we’ve absorbed on their behalf. This program started in Q1 and will be continued ongoing throughout the year. Second, we are finding new ways to improve our supply and management for translation resources. We are exploring new models for finding these translation resources such as communities and students and we are working with our existing translation resources to offer incentives for a repayment and currency changes. This should help us reduce our translation cost which is a large component of our cost of sales.

Finally, we are reducing our head count as I mentioned and trimming lease expense specifically in our European offices, so with these several specific and well defined plans we expect that they should have about I don’t know is it a $5 million, is it a $7 million run rate in the last three quarters of this year. These actually should allow us to manage our overhead costs appropriately without overreacting to a temporary currency situation.

So in summary our growth is returning. Our technology is opening up new channels. Clearly the year-on-year decline in the dollar continues to hamper our GAAP earnings but our cash yield is pretty positive. All major banks are predicting the dollar will strengthen in the coming months. Is that four, is it six, is it nine months, but somewhere in that timeframe but however, we are taking additional steps to further manage our costs and mitigate currency exposure. These actions combined with our projected revenue growth point to a strengthening Q2 and profitability for second half of 2008.

So, now I will turn this over to Don and he can talk about his progress in a lot of the wonderful areas here of tax, currency and cash management.

Donald Muir

Thanks Rory and hello everyone.

My comments today will focus primarily on three areas; tax, cash and currency, but first let me provide some perspective on the quarter. As Rory said, currency hit us hard this quarter. What we estimated cost us about $0.09 per share year-on-year, so currency adjusted you would have seen about a penny profit this quarter even on lower revenue and sequentially as Rory said, we faced one of the most rapid and volatile inter-currency swings we have seen which presented even greater challenge. Without this quarterly currency movement, you would have seen sequential operating income improve almost $1 million from Q4 excluding restructuring. So clearly our cost reductions are beginning to have some benefit and we have more actions planned.

We solved the tax issue in Q4. Now, I'm getting my arms around the currency challenge. So I will detail our currency management actions for you shortly. But first, let me give you some details on the quarter. Revenue of $117 million was up about 8% year-on-year and at the high end of the guidance range we provided to you last quarter. While most of this increase was currency related, Q1 does tend to be our slowest revenue quarter as client programs build. We had a very solid finish to the quarter in March as sales were strong and based on our current Q2 internal forecast; it appears our organic revenue ramp is continuing to build nicely.

Gross margins were about 31% for the quarter and as we said, adjusting for currency, they were 33.6%. So you can see that currency negatively impacted us by more than 270 basis points during the quarter. For GLC, our language business, actual margins were 30.2% in Q1. In year-over-year cost and currency, these GLC margins were 33%. In GDT, our development and testing business, margins were 36.2% in real terms. Currency adjusted those GDT margins were almost 40%, marking the highest margins in several quarters.

At the operating income level, tax restructuring we improved about $115,000 sequentially from last quarter, despite the 5% sequential increase in the average quarterly euro exchange rate. If currency had just stayed flat with Q4, you would have seen about $900,000 of improvement in Q1. This reflects the positive impact of our cost reduction actions.

As you saw, we had $2.4 million in other expenses. This is essentially a non-cash expense but it makes up about half of our net loss during the quarter. This was all currency related, basically the impact of revaluation of inter-company transactions on the balance sheet. This exposure was partially offset by the currency hedging program we have in place.

Our GAAP loss was $0.08 a share. As I said we estimate that FX cost us as much as $0.09 per share on a year-on-year basis despite any uplift we gained in revenue. So, currency adjusted we estimate that you would have seen a $0.01 profit this quarter.

Finally we consumed cash of $6.9 million during the quarter. We typically consumed cash in Q1 and then generate solid cash flow throughout the year afterwards and our cash balance remains strong at $26 million even after spending approximately $2.3 million in cash during the quarter to buy back stock. So, to summarize at a high level, revenue was strong year-on-year, currency adjusted we improved our margins in operating income year-on-year and cash remains strong.

Now, let me provide some detail on my progress on tax, currency and the balance sheet. Then I will update you on our guidance for the year given the currency environment which has changed significantly since our last call. As you may remember my first and highest priority when I joined Lionbridge two quarters ago was to address our inefficient tax structure. We made significant progress in Q4 and we continue to improve this in Q1.

This as a result of our ongoing initiative which changes our statutory tax filing positions and more accurately portions are revenue and profits among our foreign and domestic subsidiaries. So, our tax provision for the quarter was only $616,000 a decrease of almost $900,000 from last years Q1 and approximately 60% of that 616K was FIN48. So, we continued to manage tax with this new structure, but we also decreased our tax consulting expense during the quarter. Looking ahead to the rest of 2008 we continue to support our estimated tax provisions of $4 million to $5 million for the full year even as profits increased.

My second priority was balance sheet management. In Q1 we consumed cash as we typically do during the first quarter. The seasonal cash consumption is due to a number of factors including the revenue ramp at the end of the quarter. Customers generally start slow in the year on all fronts. Projects take a while to begin and collections tend to be slower at the beginning of the quarter, but again projects ramped nicely during the end of the quarter and collections did improve.

Our first quarter ending cash balance was $26 million and that is after using more than $2 million to buyback stock during the quarter and as we already pointed out, we can easily run this business with cash in the $18 million to $20 million range, so we feel very good about our cash position. We had a simple DSO of 60 days which is down five days from last year. So we are seeing some improvements in working capital but we still have more work to do here.

Deferred revenue decreased during the quarter. This is largely because of an unusual increase in deferred revenue in the fourth quarter related to a few large programs that had prepayments associated with them. Our net debt position is about $46 million which is a comfortable level. As you know we have authorization from our board to buyback stock when appropriate. We will continue to evaluate the most effective use of our cash and prudently manage our working capital requirements particularly given the global credit market instability.

Finally, let me touch on currency management into new class reduction initiatives that we are currently implementing. As I mentioned we had about $2.4 million of other expense in the P&L which is due primarily to Q1 balance sheet revaluations of foreign currency denominated assets and liabilities. We have mitigated this exposure through our hedging positions. In fact our hedging program benefited us by $3.4 million in the quarter. So while the $2.4 million of other expense was clearly painful making a path of our total GAAP loss during the quarter, it would have been about $6 million if we didn’t have successful hedges in place and again, this is a non-cash expense.

In addition to this other expense items, as we have said, currency hurts us in the margin and operating expense lines because the majority of our infrastructure expenses is in Europe and other non-US regions. While we do not currently hedge our income statement, we have been focused on reducing our P&L currency exposure by using our technology to improve margins and cutting overhead costs.

As you saw in Q4, we reconfigured our two offices to reduce overhead and based on our operating income improvement ex-currency, the benefits of these actions are starting to show. However, we have decided to implement additional cost management actions to further mitigate our currency exposure. Step one is to work with our customers to offset some of the currency impact we have absorbed on their behalf and we are putting currency clauses in the contracts to ensure that we are protected going forward.

The second initiative is to manage our translation resources. As you know, we outsourced translation to third-party translators around the world, largely in Europe. This model gives us the language and domain expertise we need for customers and the flexibility we need to manage our business. However, this model can have negative implications if currency moves significantly during the timeframe of the project as we saw in Q1. So we are working with our translator management group to implement new programs such as accelerated payments to take advantage of purchase discounts. So I'm not afraid to use our balance sheet to reduce costs where applicable.

Step three is managing our costs through headcount reduction. We have initiated a number of actions which will reduce our employee costs and our infrastructure costs specifically in Europe. The cost management task force is in full swing. I think the team has done a good job to mobilize quickly and implement these new cost reduction programs. These should minimize our overall cost throughout the balance of 2008.

So in summary, revenue appears to be strong and growing across our business. I spent some time in Q1 visiting our operations and finance people in Europe, India and Asia and I have to say I'm very impressed with the quality and caliber of the teams and I continue to be enthused about our market opportunity and customer loyalty.

Currency has clearly impacted our profits particularly given the volatile decline of the dollar during Q1. We are taking a number of specific immediate actions to further reduce our cost and minimize the impact of currency on our business. We continue to manage tax within our new structure and our cash balance remains strong.

Given this context, let me wrap up by talking about our outlook for the second quarter and the full year in a little more detail. For the second quarter, we estimate revenue of $120 million to $124 million reflecting our strong pipeline of current business. For the full year; you may remember that when we provided our 2008 outlook on the last call, we assumed a euro dollar exchange rate of between $1.45 and $1.48. We are sitting today at about $1.55. Therefore, on the revenue side, we estimate that we will be in the high end of the 6% to 10% revenue growth range we provided previously.

We now expect gross margins to be a bit lower than 2007 and total operating expenses to grow about 6% year-on-year. This reflects our new assumption of a dollar euro exchange rate in the range of $1.53 to $1.55 for the remainder of the year offset in part by our new cost reduction activities.

All major banks are predicting a strengthening dollar in the second half, some as low as $1.40 and some into the $1.30 range. With that said, we feel it’s prudent to update our forecast to reflect the current FX rates. If the dollar strengthens as predicted, the positive benefits of our cost management actions will be even greater. The other expense line should also decrease in the coming quarters assuming the inter-quarter currency movement stabilizes. So we don’t expect to see much of a dramatic impact as we did in the first quarter.

We continue to manage our tax expense and reiterate our estimate of a tax provision in the $4 million to $5 million range for the full year. All this points to increased revenue momentum in Q2 and to accelerate profitability in the second half of 2008.

Rory, back to you.

Rory Cowan

Thank you Don. So before we open up for questions, I would just want to make it clear that Don has really wrestled that tax bearer to the ground and now we have the currency snick to get a hold of and so the balance sheet continues to strengthen and cash also is really very strong for us.

In addition, our operations teams -- we have sort of reconfigured our operations orientation here and we are beginning to really focus quite heavily on our cost management activities of being able to move more business to the appropriate location for both cost and capability.

So overall, Q1 operationally was, as I said a workman like quarter despite the currency headwind. Customer demand is strong. Growth feels -- forming our pipeline is really very, very solid and our proven technology services model is opening new channels for us as we had planned during last year. So all this gives us a pretty solid platform to the remainder of 2008 and as Don said, even though, most people are expecting a strengthening dollar in second half, we are giving our outlook really with the current currency environment.

So let’s open it up for some questions

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question comes from Brian Kinstlinger, Sidoti.

Brian Kinstlinger - Sidoti & Company

Hi, good morning guys. The first question I have is you mentioned that the way to look at this given currency is gross profit dollars. So if I take a look at a constant currency basis, revenues flat and gross margin dollars are flat based on some of your comments and it looks like earnings will both be $0.01 year-over-year. So I'm just curious what are the factors excluding currency that are driving what seems to be flat results year-over-year and obviously both of your weakest quarters that show year-over-year comparisons, and maybe what am I looking at wrong there.

Rory Cowan

I think a couple of things here, Brian. First, we spent Q1 managing our volatility more than anything else. Second, in our gross margin dollar level, there are lots of ins and outs on individual projects there. I am actually, given the currency year-on-year was -- I don’t know, what was it, 14%, 15%, something like that? And you had that 7% within the quarter. You put a bid on the street and it comes back four days later, you have to re-bid it again because of currency. I'm actually very pleased that we were able to hold those numbers year-on-year given this instability.

Brian Kinstlinger - Sidoti & Company

Okay. In terms of pricing as well as currency clauses, first of all I'm interested to hear -- I mean the cost of business is outrageous right now obviously in Europe. I'm interested to hear what kind of price increases you are trying to push -- you acquired your biggest competitor. So it seems like my other companies have been able to push some pricing increases? Second question is, that coupled with currency clauses, how open are your customers? Are they pushing back on that? Are they understanding? Give us a sense of when that might also have an impact on the numbers?

Rory Cowan

I think some -- nobody likes prices to increase. I mean you don’t like your Starbucks raises the prices in your morning coffee because of coffee prices in Brazil. Clearly, they are also -- we are dealing with customer by customer. Our larger customers actually with the large programs actually understand this change because they are gathering so much benefit from the euro-euro sales that they have. I don’t want to say it’s a flight to quality but we are finding larger programs with larger European presence really and to understand our situation; that’s point one. Another sector that has much more flexibility and pricing understanding our current models is the general life sciences world because of course there are high costs of failures, so the higher quality segments and those that are enjoying strong international. The traditional areas -- that don’t like price increase are the smaller software companies that are in Europe for the first time or two. They too are experiencing lots of headwinds in their European expense structure before European revenues come in. So it’s various price segment Brian. We are a $0.5 billion company now and I can't say that our customers want this because it’s really -- we probably address maybe 15 or 18 individual segments when you segment it by application, customer size and geography.

Brian Kinstlinger - Sidoti & Company

Okay. I guess then your company is a top player in the space, there is lot of current competition. So clearly someone would argue that you have a lot of value in your business, so I'm curious at what point if you can’t raise prices to certain customers, not all, you just walk away from them and say “well gee, this is unprofitable for us. We can't do business with you.” I mean it seems to make business sense, so I'm curious what your thoughts are on that.

Rory Cowan

I think I said that in my comments that we are focusing on more profitable projects. When I said that the pipeline is firming in spite of it we are being a little bit choosy with particular customers now. So that’s obviously the direction we are going, Brian.

Brian Kinstlinger - Sidoti & Company

Okay. In terms of lease expenses and headcount reductions you talked about; are these new leases are the ones that you already talked about in Germany and New York? If so, can you maybe talk about where they are and in terms of headcount reductions -- the European, because I know that when you had some layoffs in the past especially from BGS. It took a long time for that to happen. So I'm curious, you expect some really near-term benefits from that. Why is that different than last year when it took a while to get it out?

Rory Cowan

I think a couple of things. First, we are decreasing Europe now over 50 people year-on-year, so that’s feeling very, very strong given the -- not only the currency impacts year-on-year but of course the social costs associated with European employees. Much of that work has moved to our offshore locations. That’s feeling pretty positive. In the leases, every time a lease comes up, we are moving our European facilities to smaller locations because we have a lot less headcount in Europe and were able to execute more in the crowd and more offshore. This is not something that all of a sudden that in Q2, you are going to see $2 million of lease expense to disappear. This is a thoughtful process that we are doing every year, every quarter, every time a lease rolls up. I think we have what? About 50 leases or 40 leases around the world; one is coming up every four to six months and we are just doing it bit by bit. So I think that you will see about $5 million to $7 million of reduction that should flow through cost of good sales and SG&A during the second half of the year.

Brian Kinstlinger - Sidoti & Company

In terms of headcount, did you say there were headcount reductions? Did you say that and where are those happening?

Rory Cowan

I think I said that we were already down year-on-year about 50 people and we will be taking clearly as I mentioned when people leave, we don’t replace them in Europe when we reconfigure work elsewhere. I think take the number of that $5 million to $7 million number is really what the focus is. How we get there will be a combination of facilities, people and technology.

Brian Kinstlinger - Sidoti & Company

Right; two more questions. First of all in terms of personnel cost, salaries on the SG&A side totaled for the Company, are those as a percentage up or down as a percentage of revenue.

Rory Cowan

We are probably seeing some growth certainly related to the FX as we get a light percentage of our expenses now-a-days in foreign currencies as we discussed in the call. Obviously we have a big uplift year-over-year by 15% just from currencies, so those…

Brian Kinstlinger - Sidoti & Company

What about on the constant currency?

Rory Cowan

Those are heading north. Constant currency due to the head count reductions they are pretty stable.

Brian Kinstlinger - Sidoti & Company

Okay and then two house keeping. What do you expect stock based compensation for the year and I missed the GLC gross margin on a real basis if you can give me that please?

Rory Cowan

GLC gross margin in the first quarter was 30.2%.

Brian Kinstlinger - Sidoti & Company

Okay and do you have an expectation for stock comp for the year.

Donald Muir

We haven’t given any guidance but it’s probably similar in the $6 million range.

Operator

Randy Hugen with Piper Jaffray.

Randy Hugen - Piper Jaffray

Thanks. What’s your organic growth excluding currency implied by the high in that 10% revenue growth number for the year.

Rory Cowan

Q1 was up about 2%, so we had significant benefit obviously from the currency uplifts. It’s not going to be quite that great or dramatic during the rest of the year as the currencies -- the rates are higher. As we go forward comparisons shrink a little bit.

Randy Hugen - Piper Jaffray

Right and so I think that it was -- currency was the majority of it during Q1; of course during Q2 and Q3 given the guidance as we are. You do the currency math and that organic growth returns in the middle of the year as it always does.

Rory Cowan

Alright so, there is obviously a nice sequential drop in G&A and you have talked about some of the additional efforts that you have going on. Is it reasonable to assume that we could see another $1 million to $1.5 million per quarter move out of G&A as we go through the year?

Donald Muir

As we said, we expect our expenses, operating expenses to be up about 6% year-over-year, so we do see some decreases certainly going forward.

Randy Hugen - Piper Jaffray

And when you talk about operating expenses there are you including the cost of goods.

Rory Cowan

I am looking at the entire loan yes.

Randy Hugen - Piper Jaffray

Alright, so if currency levels here…

Rory Cowan

They are up with revenue and operating expenses be up about 6%.

Randy Hugen - Piper Jaffray

Alright, if currency levels are here -- how should we look at gross margins for the reminder of the year?

Rory Cowan

As we said year-over-year we expect to be down slightly.

Donald Muir

I say there is a faster down range. You don’t model things up. If the currency turns around our way it’s a bonus for us.

Randy Hugen - Piper Jaffray

Okay and then one more here. You mentioned that your largest clients are growing faster in the overall business. Are you expecting that to continue then also is there a particular group of clients that’s offsetting the growth in the large clients.

Rory Cowan

Yeah, I think we said our large clients are growing. We have always talked about for the past two or three years of trimming a lot of the smaller $700,000, $50,000 a year our clients. Following up on the earlier question that we had we are looking at the total profitability of the business as well. We are finding -- we do much better with larger customers with larger multi-year programs. It’s becoming a multi-year outsourcing business unlike the two or three years ago which was more episodic project based business. So this is just what we hoped for to happen.

Operator

Joseph Vafi, Jefferies & Co

Joseph Vafi - Jefferies & Co

Hi, good morning Jo Vafi from Jefferies here. Just a couple; circling back on the currency just for a second, Don do you have a quick metric for example on a change to margin or a 1% change to the euro given a fixed mix of revenue coming from the different geographies. Is there a little formula that we might be able to think about on that front?

Donald Muir

We can crunch through the math. We can see it was pretty dramatic if you look at the year-over-year change with the euro. 15 points change in the euro we actually had an increase in cost and currency gross margin. Sequentially we also had an increase in gross margin in cost and currency, so I guess it depends what your base of comparison is if it’s year-over-year or if it’s sequential but it’s still going to impact us on the gross margin line. I don’t have a quick and dirty chart that I can share with you on that.

Rory Cowan

Jo, that’s a good question because we are trying to get a sense of given that it feels that as if the dollar or the euro has peaked now and we are trying to get a sense of what that headwind, when if it becomes a tailwind or what it will do for us. Clearly it will reduce our revenue growth even so we have given you revenue guidance at the high end of our prior range and I also think it little clean up our -- we will get better with gross margin. Other income, other expense should deteriorate, I mean should be more positive just given the positions of loans and things. We will try to think about what a sort of 1% equals what kind of idea for you.

Joseph Vafi - Jefferies & Co

I think the best way now would be look at it kind of just sequentially from here forward and a year ago is a long time ago and there is a lot of things that the company has been doing to tweak their cost structure and other things, so I think the best way to look at it would be moving forward.

Rory Cowan

You know sequential as Don said we had much stronger operating performance in cost of currency in sequential quarters. So all the things that we are doing are beginning to take hold here just hasn’t come through to you guys yet, so we are feeling good about where our directions of operations. We just have to get out to you guys.

Joseph Vafi - Jefferies & Co

Right.

Donald Muir

Joe you have to remember we have two components right as Rory said. We have the income statement impact, we get the balance sheet impact. Obviously we took a $2.4 million hit to other income on essentially what was a 4% change in average currency rates during the quarter, so if currency is neutral that pretty much will go away.

Rory Cowan

Alright and you understand that other income, other expense these are inter core balances, so that the US subsidiary owns our German subsidiary some unsettled receivables or payables. You have to revalue that at the end of the year even though all that stays within our corporate balance sheet. So, it’s really a funny GAAP metric, that’s why I don’t think GAAP as an accurate reflection of what we are doing here.

Joseph Vafi - Jefferies & Co

Right understood. Just then switching to the tax side of things, sounds like some good progress there in the quarter. You looked at what you have to do Don -- how far along you think you are now in a kind of grand scheme of optimizing the tax structure here.

Donald Muir

Given that we had a $600,000 tax provision in the first quarter, 60% of which is a FIN 48 adjustment. You can see that our overall tax is pretty diminished so we have done a very good job I think of accurately portioning the foreign and domestic income into the right buckets. We still have some additional work to do on that front, but I think with the bulk of the heavy listing is certainly behind us. The issue you have with any tax line management is to ensure that your tax provisions stands up under audit and the tax filings you make in the statutory level end up in refunds and not additional payments. We are still early in the game but we have got a lot of the heavy listing behind us. So we are very pleased with the Q1 results and we are maintaining our guidance in the $4 million to $5 million range for the full year but obviously, given the Q1 provision, we have a shot at perhaps being in the lower end of that range but we still have some more due diligence to do around some legacy items in the tax arena and we are very focused on doing that.

Rory Cowan

As you know, we do have a new tax director here that is really getting his arms around all this stuff. So that’s one -- I think that process is well underway for us to get our arms around it.

Joseph Vafi - Jefferies & Co

Okay, great, and then maybe just one final question. As we move through the year, you are kind of talking towards the high end of the revenue range and as we move through the year, as Don said, the FX effect will be probably smaller as we kind of have higher euros in the year ago quarters coming up. Are we saying that we are really seeing some real acceleration to the business or at lease some -- we are forecasting some model acceleration of the business here, FX aside, looking out for the rest of the year?

Rory Cowan

We have done quarterly -- now as I mentioned, we have sort of shuffled some operating management here and so we are now really doing much more by line of business, sort of bottoms up forecasting on rolling quarters and rolling months and what we are seeing is strong firmness and real terms firmness for the second half of the year, so that’s the feeling and this is of course the time, Q2 and Q3, is when we traditionally have our strong ramp and that last year, we didn’t have the softness in Q4 to actually stay at that level, so we continued to ramp up. It maybe that the export engine is finally beginning to kick in, in the US but we are just seeing there is firmness across pretty much all areas and we are looking for a really good organic growth for the second half of the year.

Operator

Matt McCormack, FBR.

Mat McCormack – FBR

Yeah, hi. Just a follow-up on the pipeline comment you were just making. In terms of these larger multiyear deals, have you not seen any kind of a delay in the sales cycle or any kind of trepidation on the part of your clients as compared to a year ago?

Rory Cowan

In terms of -- we have been pretty sensitive to that. I think as I mentioned Mat, smaller companies that are just starting their international rollouts, I think that there is some hesitation in those larger companies that have proven global markets that are really benefiting from the euro-euro revenue conversion back into dollars right now. We are not seeing much hesitation there at all. In fact, the large companies, meaning $1 billion plus that have had a couple of hundred million dollars of international revenue, this is where we are seeing great strength; in fact if anything there is a pickup there because European revenues are so valuable to dollar based companies right now. So those are really the ones that we are looking at and with a slow start to Q1, but I always say that Q1 is a ten week quarter because the first two weeks, people just aren’t that focused on their jobs, budgets haven’t been frozen yet, people haven’t closed the year-out, etc, etc, etc and then things really begin to pick up and this March right on schedule they did and it’s clearly moving into April and May for us as well.

Mat McCormack – FBR

So, as the model shifted more long term revenue -- larger clients, less small clients looking at ’08. I mean what percentage of visibility would you say that you have in terms of deals that are already signed?

Rory Cowan

What we really talk about having about 60% of our business booked in bills going into the quarter is will that be nudging up a little bit? Yes, probably and our forecasting systems are really suggesting that. I don’t want to give a specific point forecast but I will tell you that we have more visibility of more business earlier in the quarter; a very different business model than 18 to 24 months ago and that’s part of our strategy. As you know we were -- we started 18 or 24 months ago just after we bought BJS to pair away some of the smaller accounts.

Mat McCormack – FBR

Okay and then in terms of your buyback could you just remind us how much is left on that and just kind of discuss your priorities for cash; whether to buy more stock or start paying down debt?

Rory Cowan

I think two things. We have about $10 million left on the authorized buyback; that’s the second buyback. Of course the first one, we did the full 12, we had authorized another 12. We are about 10 left on it and we are being thoughtful about whether we are going to pay down debt or whether we are going to buyback more stock and we also -- just given the – there’s the funky credit world right now. I think there is just some prudence which suggest to get another quarter or two under our belts and our bank lines are fine, everything is okay, but I just have been seeing -- I don’t want to have any sort of liquidity issues here. So we are just being a little cautious keeping cash may be a couple of million dollars heavier then we might like than perfect financial management might call for but we have lots of room left on the buyback and we have lots of cash generation capability for the second part of the year. Don you want to add to that or….

Donald Muir

No, I think that it’s important to remain prudent and cautious in the current credit environment and be opportunistic from a buyback perspective but it’s a very tribunal time right now in the financial markets.

Operator

Marty Wales, UBS.

Marty Wales - UBS

The problem I have is this and most of the specific questions have been answered, but global trade is growing, you are the largest grower in the block in what you do. You are the most automated. The currency thing has faced us for a couple of years and you can’t make a decent profit. The question is whether the model just might work or is it just isn’t being executed properly. In previous comments you indicated given the global scope of the business you need to have size; that was one of the reasons for the merger in first place and I am just wondering if you would make a comment now about whether you ever think you will able to do on a normalized basis the 5% after tax or you need to grow the revenues another 50% to be able to do that. I am just trying to get some sense of where we need to look in the future.

Rory Cowan

Right, no those are good questions Marty. I think there are a couple of think. First, the big issue that we had here and I think we came to terms with is the imbalance of the euro dollar, cost versus revenue ratio and when we bought back as you mentioned, the euro dollar was, I don’t know 1.18, 1.22, somewhere in that sort of range and we have gone $0.40 in less than 18 months here. When you have that amount of fixed expenses in Europe and that amount of dollar contract customer relationships, it’s very hard to make the math work that quickly even though we have gotten more sophisticated with our hedging capabilities. When we did our due diligence and balance, currency volatility and looking at $1.60 -- two years ago if you thought there’d be 1.60 euro when a $120 barrel of oil, people would have laughed at you; two years ago now, we are sort of looking at that’s normal life, so I think we are on the wrong side of that trade. I think as Don mentioned, we are getting stronger operationally every quarter here in things we are doing. I don’t think we need to buy another $50 million or $100 million worth of services; don’t worry about that. There are some things we can do to transform the model by using more sort of internet orientation; community based global community translation activities. I think that we have mentioned about -- we are beginning to see more and more individual translators come directly to us in various locations in our search relevancy business we are contracting. We have a couple of thousand individuals working from home around the world for us and that’s a very fast growing business for us, so don’t think you need another acquisition. We just have to get our arms around this currency thing and I think this 5% after-tax is certainly a realistic goal.

Marty Wales - UBS

And the only -- I appreciate that. Your suggestion is that probably you have more ability to raise prices than you imagine. I would like to see -- I guess try and to be more aggressive on trying to raise your prices is one of the previous questions as you referred to.

Rory Cowan

Yeah and I think that maybe I wasn’t as clear on my call. We put together a group and with some of our -- I mentioned our larger customers fully understand the intricate program for global deployments that they have and also the dependence on their international activities and so had we been a little slow in that probably as I really wanted to get our arms around some of the financial, operational issues and with Don’s arrival here we got stability here now and so we are feeling as that’s a large part of it, but it’s really raising the bridge and lowering the water. It’s not one thing. When you are work in the business of this size, you got to do both.

Operator

Thank you. (Operator Instructions) Brian Kinstlinger, Sidoti.

Brian Kinstlinger - Sidoti & Company

Just a couple of thoughts from other questions. First of all what’s your personal organic growth? Do you think that you impacted it all by the economy and the weakness in the US or across the world and give us a sense of are there a couple of delays that you were expecting any faster. I know you are hitting your numbers certainly but do you think that’s why maybe organically it’s a little bit slower than maybe it has been in the past?

Rory Cowan

I think that we were just more selective this quarter and focusing on the larger accounts that we thought had more long-term potential, so that maybe some of it. Secondly, pricing, the book and bills in the quarter as I mentioned, it was a hell of a time to try and put a price on the street because you would have -- a quote that you put on the street, say you had a one year quote, you put it on the street in the first part of the month and then the currency goes up 4%. Six weeks later and the customer shows up and says “fine I’ll take it.” You got to say “Well not so fast” because 4% going forward, there goes the 5% after tax that Marty was talking about in the prior call. So there has been a lot of management in this volatility issue here Brian and as I mentioned there is a great firmness. I think this export engine is really kicking in among the more matured companies that have really already built their infrastructure so they can jump on it quickly. We do see smaller companies struggling a little more as they begin to realize just the cost of doing business in Europe, setting up operations in Europe; it is just much more expensive, so there may be softening there Brian so your intuition might be correct.

Brian Kinstlinger - Sidoti & Company

But you are quoting in Euros right now, you are not quoting in dollars.

Rory Cowan

We quote and a number of others -- if you are buying in the US, you don’t buy a BMW in euros and you walk down the street and pay in euros. Our customer has the dollar as the currency. We used the euro to determine the dollar price and as we mentioned we are putting in some currency collars on these new contracts that are growing out as well.

Brian Kinstlinger - Sidoti & Company

Okay, in relation to Joe’s question about the margin you mentioned there was a 5% swing in the euro and at the same time you mentioned what your margins would have been. So it looks like there’s a 260 point swing from a rule of thumb the equation that we hear better is a 5% ratio to the 260 point gross margin move. Is that something people take a little bit of how we should think about it as margins move in the next couple of quarters -- I mean as rates move in next couple of quarters?

Rory Cowan

Brian those are big numbers to decide. I don’t think Don or I would like to make a specific ratio on the phone but directionally it feels about right but -- plus or minus a 100 basis points. I wouldn’t want to put that kind of point.

Donald Muir

I think that you are going to need to grind through the numbers. As you said if you look at the -- on the gross margin line you can probably isolate that a lot better than the balance sheet impact that you see during the quarter that will pursue the other income and expense line. Even if you look at year-over-year the mix of currencies have a pretty severe impact on trying to do that type of math because you got a very large movement year-over-year, a small movement sequentially so. I’ll let you do the math in that Brian.

Brian Kinstlinger - Sidoti & Company

Okay and on the hedging that you mentioned. I am curious how hedged you are and what I mean by that is you had quiet a considerable amount in cash expense there but you are headed there some curiousness in the second quarter. Are you opened to large swings such as that -- as currency moves as it did this quarter.

Rory Cowan

We tried to hedge about 80% of the balance sheet visibility that we have, much of that is in our company. We are not doing any P&L hedging as I alluded to.

Donald Muir

That’s right, that’s actually derivative.

Rory Cowan

So we are certainly exposed to currency movements.

Donald Muir

And again I don’t think a more expense stock there is essentially non-cashed. That’s what -- I guess I think I have this volatility as since the majority of our currency exposure has been internal I really had to look at this -- at the other cash metrics.

Brian Kinstlinger - Sidoti & Company

But you are hedging it against it with non-cash right.

Donald Muir

We are hedging against balance sheet revaluation.

Brian Kinstlinger - Sidoti & Company

Right, the last question is on interpretation. Did you get the gross margin for that segment. I wonder what’s the real one and not the constant currency.

Rory Cowan

Yeah that has very little currency exposure. Hang on I’ll get it on the screen here. That’s about 22%.

Brian Kinstlinger - Sidoti & Company

Right thanks.

Rory Cowan

That business is fairly stable, plus or minus 23, 24, 22 that was our range it hangs out, well if it doesn’t have -- that’s all the dollar and dollar based business.

Operator

Thank you. Our final question comes from Mark Cooper Wells Capital.

Mark Cooper – Wells Capital

Actually it was just answered, thank you.

Rory Cowan

Been answered.

Rory Cowan

Okay thanks Mark. If anything else comes to mind give us a call. Thank you everybody and we look forward to our next call. Thanks very much and if you have any thoughts, give Sarah a call and she will track down and Don and I will be around to talk to you. Thanks.

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Source: Lionbridge Technologies, Inc Q1 2008 Earnings Call Transcript
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