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Monotype Imaging Holdings, Inc. (NASDAQ:TYPE)

Q4 2013 Results Earnings Conference Call

February 13, 2014 08:30 AM ET

Executives

Chris Brooks - Director of FP&A

Doug Shaw - President and CEO

Scott Landers - Senior Vice President and CFO

Analysts

Steven Frankel - Dougherty & Company

Richard Davis - Canaccord

Kevin Liu - B. Riley

Matthew Kempler - Sidoti & Company

Ross MacMillan - Jefferies

Saket Kalia - JP Morgan

Operator

Ladies and gentlemen thank you for standing by. Welcome to the Monotype Q4 and Full Year 2013 Earnings Conference Call. At this time all participants are in a listen-only mode. Following the presentation we will conduct a question-and-answer session. And instructions will be provided at that time. (Operator Instructions).

I would like to remind everyone that this conference call is being recorded today. February 13, 2014. I will now turn the conference over to Mr. Chris Brooks. Please go ahead, sir.

Chris Brooks

Good morning everyone. Thank you for joining us for Monotype’s fourth quarter and full year 2013 financial conference call. I’m Chris Brooks, Director of FP&A at Monotype. With me this morning are Doug Shaw, President and Chief Executive Officer; and Scott Landers, Senior Vice President and Chief Financial Officer.

Before we begin, I’d like to remind everyone that matters we’re discussing today and the information contained in the press release issued by the company earlier this morning announcing our fourth quarter and full year 2013 financial results that are not historical facts are considered forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

Forward-looking statements including predictions, estimates, expectations and other forward-looking statements generally identifiable by the use of the word believes, will, expect or similar expressions are subject to risks and uncertainties that could cause actual results to differ materially.

Accordingly, participants on today’s call are cautioned not to place undue reliance on these forward-looking statements, which reflect management’s opinions only as of today’s date, February 13, 2014. Information on the potential factors and detailed risks that could affect the company’s actual results of operations is included in the company’s filings with the SEC. The company undertakes no obligation to revise or publicly release the results of any revision to the forward-looking statements made in our fourth quarter and full year press release for on this morning’s conference call other than through the filings that will be made with the SEC concerning this reporting period.

In addition, I’d like to remind you that today’s discussion will include references to net adjusted EBITDA and non-GAAP diluted EPS, which are intended to serve as a further complement to our results provided in accordance with generally accepted accounting principles. A reconciliation of these non-GAAP measures to their GAAP equivalents can be found in our press release.

Lastly, a link to today’s call can be found under Events and Presentations in the Investors section of our website at www.monotype.com. The call will be archived on our website for one year.

Now I’d like to turn the call over to Doug. Doug?

Doug Shaw

Thanks Chris and thank you all for joining us. Even as you may have seen in our release this morning, Monotype had a excellent fourth quarter and fiscal year. We continue to execute on our strategy to diversify the business, strengthen our offerings and an investment support of our long-term growth initiatives, all while continue to generate significant profitability and cash flow. I am pleased with how the team accomplished our goals and has established a stronger position for future growth.

Looking back 2013 was a year where we saw our customers increasingly view Monotype as a strategic partner, particularly, as I navigate today’s global digital content landscape. User experiences have become more fluent, these consumers engaging anytime anywhere on any device and in any language. Every touch point is an opportunity to create a lasting impression. And key to this our consistent branded experiences across every screen which is why customers are trying the Monotype to help them succeed in this growing arena.

In terms of performance fourth quarter revenue increased 10% to a record $43 million non-GAAP net adjusted EBITDA was $18.3 million or a 42% margin. For the full year revenue increased 11% to $166.6 million and non-GAAP net adjusted EBITDA grew 11% to $71 million or 43% of revenue.

In Creative Professional, our fastest growing business we achieved $17.3 million in revenue for the quarter an increase of 17%, driven by continued strength in our e-commerce sales momentum in our direct business and acceleration in web fonts. Revenue for the year was $63.7 million up 23%.

In OEM, revenue was $25.8 million for the quarter a 6% increase, largely led by our expanding market position in automotive and our printer business. For the full year we achieved $102.9 million in revenue a 5% increase year-over-year.

In 2013 we had record financial results in both Creative Professional and OEM, along with several key achievements including regenerated $12.5 million and web font revenue our number one growth initiative, exceeding our internal goal of $10 million.

We launched the commercial version of our Typecast application, a browser based tool for designing web pages with type. Typecast also won the Game Changer of the Year award from .net magazine. We extended our partnership with Google to bring a public version of Typecast to Google fonts enabling users to explore design or experimenting response. We enhanced our SkyFonts Technology and Google is using it to enable quick and easy fonts, I am sorry quick and easy download of their fonts. We signed several new automotive deals and now have agreements with nine manufactures and eight tier 1 suppliers.

We launched the Monotype baseline platform which lets OEMs and independent software vendors build products to take advantage of our fonts and the cloud. We released beautiful type phases on the Monotype Studio, such as Metro Nova already one of our best selling fonts.

And we launched our eText collection designed for high legibility in digital leading environments. We expanded Japanese collection which now represents one of the world’s largest portfolios with more than 500 fonts. In the New York City, we held our Pencil-to-Pixel Exhibition which brought to life Monotype’s brand story for historical perspective, as well as the importance of type, yesterday, today and tomorrow.

Today we are more diversified Monotype providing critical value to our type phase’s technology and expertise. Our footprint extends across all phases of the content continuum from content creation to distribution to consumption. In 2013, the use of Web Font accelerated in a creative professional business as brand looks to enhance their web presence with beautiful typography.

We continue to attract major brands like Levi’s, Tommy Hilfiger, Maybelline and [Caterpillar]. More recently we added customers like (inaudible) QuickBooks and Curves 2013 was a year where responsive design came to the forefront, which is goal of crafting at single, optimal viewing experience that works seamlessly across every stream. Yet most brands are still in the early stages of this transition. For example 93% of the leading consumer magazines in the U.S. UK and Germany have yet to offer a viewing experience that's optimized for multiple devices. A binding we reported last spring to our brand’s perfect initiative. Successful cross platform experiences require fonts that ensure grand fidelity, legibility and worldwide language support.

To that end Monotype is taking a leadership position to help brands transform their presence to fit in multiscreen world. Looking ahead with responsive design as a back drop and as emerging trends like HTML 5 advertising take hold, we see web fonts continuing to represent a significant opportunity for growth.

During the year, we focus on solutions that enable creative freedom. For example our Typecast application is paving the way for designers to build websites more easily and deliver content that is readable, accessible and attractive. We believe that great design starts with great type and with tools like Typecast, beautiful web Typography is now more possible than ever.

In our direct business, we continue to see an increase in the number of large recurring deals. We worked closely with brands like Pearson, the world's largest education company to maximize their Typographic capabilities online, in prints and in the software offerings. Pearson also represents our first large scale Typecast application, with more than 2,500 seats giving Pearson a companywide foundation to accomplish great design and optimize work flows.

From a customs font perspective, we work with brands like Sony, who turn to Monotype to design a corporate typist, one that’s solid yet timeless and highly legible at small sizes. Sony’s new branding type supports an impressive 93 languages and is designed to provide the same unmistakable Sony brand experience, anywhere in the world on any device.

Turning to OEM, 2013 was marked by progress across the wide range of categories, including automotive displays, TVs, medical instruments and games. We also expanded our value to independent software vendors, working as a strategic partner with customers like Apple, Microsoft and Google, helping them to meet the needs of revolving world markets. In print imaging we continue to experience growth in the mid single-digit, as the industry capitalize in emerging markets, such as China.

Now I’d like to turn to our 2014 outlook. For the full year, we expect revenue to be in the range of $180 million to $185 million or growth of 8% to 11%. We anticipate net adjusted EBITDA to be in the range of $74.5 million to $78.5 million, which represents a margin of approximately 42%. In 2014, we expect Creative Professional to continue to lead the way, as more companies are trained to Monotype to help them optimize content of the digital world.

In OEM, we expect accelerated growth in automotive, while more mature pricing [crunches] continue to provide a stable revenue stream. Operationally, we expect to focus on four key areas. These include, web fonts, which has been a key initiative for the past few years. We expect to add more value to our offering and our goal is to generate $17 million in revenue, approaching almost 10% of our total revenue for the year.

The second area of focus is independent software vendors, which have always played a significant strategic role for Monotype. And with expanding opportunities through cloud-based platforms, we intend to reach new markets more quickly. Our goal is to help ISVs effectively capitalizing categories like mobile apps games and content creation.

The third area is automotive. Our focus to add new customers and work with existing accounts to broaden deployment and geographic reach. We will continue to invest in this business, while ensuring that legibility remains front-end center as a critical element of the driving experience.

Finally, the fourth area is digital advertising. Looking ahead, digital ads using web fonts could be a major opportunity. We plan to invest significant resources to better understand the ecosystem and emerging standards, our line of offerings and the established meaningful partnerships. In all four of these areas we intend to build our position through a combination of reallocating resources, incremental spending and where appropriate augmenting with acquisitions.

At this point, I’d like to turn the call over to Scott. Scott?

Scott Landers

Thank you Doug and good morning everyone. I’d like to start by reviewing Monotype’s financial performance and provide more detail on our outlook for 2014. Revenue for the fourth quarter increased 10% to a record $43 million. Creative Professional revenue increased 17% to $17.3 million driven by success across both our desktop and web font offerings.

Our web font growth accelerated in 2013 and we ended the year with more than $12 million in revenue. Our offering is satisfying the needs of a much larger section of the marketplace, our core fonts IP is enabling well known brands to bring their content to the digital world. In addition, our MyFonts website and business model is creating a marketplace for boutique designers to offer their type to the masses.

We continue to strengthen our competitive position by integrating complementary technologies by Typecast and believe that we have laid the ground work to capitalize on future growth as the market transitions to mainstream adoption. For the fourth quarter, OEM revenue met our expectation and grew 6% to $25.8 million.

Now let’s turn to cost and margins. Gross profit margin for the quarter was 84% of sales. We expect the go forward margin continue to track to our typical rate of 82% to 83%. Operating expenses totaled $23.1 million, an increase of $2.9 million or 15% compared to the prior year. The major drivers of the increase were personnel expenses; web-related expense and share-based compensation.

Operating income increased 9% to $13 million or 30% of revenue. GAAP net income for the fourth quarter was $8.1 million, earnings per diluted share were $0.20 and non-GAAP earnings per diluted share were $0.28. Net adjusted EBITDA increased 11% to $18.3 million or 42% margin.

Turning to our full year results, from an execution standpoint, 2013 was a great year for Monotype and that is reflected in our financial results. Execution against our strategic initiatives combined with market expanding acquisitions has enabled our Creative Professionals business more than double since 2011.

To recap the year, revenue increased 11% to $166.6 million. Creative Professional revenue increased 23% to $63.7 million and now represents nearly 40% of our revenue. OEM revenue increased 5% to $102.9 million. Printer Imaging performed as we expected and solid industry growth rate. And our emerging growth opportunity in automotive grew in excess of 200%.

Operating expenses increased 12% due to personnel cost, incremental marketing expenses, share-based compensation and amortization. Operating income increased 9% to $50.7 million or 30% margin. Earnings per diluted share were $0.78 and non-GAAP earnings per diluted share were $1.10. Net adjusted EBITDA grew 11% to $71 million or 43% margin. Cash flow from operations was $51.3 million for the full year.

Turning to the balance sheet, cash and cash equivalents at year-end stood at $78.4 million. Our business model of recurring revenue and profitability puts us in a unique position of being able to fund growth, as well as returned cash to shareholders.

In 2013, we increased cash by almost $40 million, paid down $22 million in debt. Returned $8.5 million to shareholders via dividends and repurchased $2.2 million worth common stock.

Cash generation is one short-term metric that speaks to the strength of our model. Longer term, we expect to draw strength from the diversification of the business. We are now more diversified than ever across our revenue streams. We are also well diversified within each of those streams. For example, our OEM business drives revenue from over dozen device categories, hundreds of manufactures and all of the major software operating systems. With Creative Professional, we source revenue from both direct sales and e-commerce channels, which enables us to reach millions of customers across the globe.

Lastly, our business has provided us with a highly recurring and predictable revenue stream. Today, more than 85% of our revenue is recurring for predictable. Our value propositions lend themselves for long-term customer relationships. A great example of expanding value translating to recurring revenue and be found within our Creative Professional business.

Just a few years ago, we estimate that less than 10% of revenue generated by our direct sales force was recurring. As customers needs have expanded in the digital world, we’ve responded by delivering more value, solving more problems and today approximately 50% of their revenue stream is recurring. Based on this solid foundation, our Board has approved a 33% increase in our quarterly dividend. Our next dividend payable in April will be $0.08 per share.

Now I'd like to turn to 2014 guidance, which is in line with a high level view shared on our last earnings call. Monotype enters 2014 with exciting long-term growth opportunity. For the first quarter, we anticipate total revenue of $44 million to $46 million, which represents growth of approximately 7%.

We expect gross margins to approximate 82% to 83% and operating expenses to be approximately $24 million. We expect net adjusted EBITDA to be in the range of $18 million to $20 million. Non-GAAP diluted EPS of $0.27 to $0.30 and GAAP diluted EPS of $0.19 to $0.22.

For fiscal 2014, we anticipate revenue growth of 8% to 11%, which equates to revenue of $180 million to $185 million. We expect gross profit margins to approximate 82% to 83% and operating expenses to be approximately $98 million.

We expect net adjusted EBITDA to be in the range of $74.5 million to $78.5 million. Non-GAAP diluted EPS of a $1.12 to $1.18 and GAAP diluted EPS of $0.77 to $0.83. We expect strong double-digit growth from our Creative Professional business, as customers continue to capitalize on the opportunities in digital content.

OEM growth should trend towards the mid to high single-digit range. On a quarterly basis, we expect a revenue mix similar to 2013. From an investment perspective, emerging opportunities in digital content are now making a meaningful topline financial impact. But we are still in the early days of the growth curve.

We will continue to impressively fund our strategic initiatives to better understand the market opportunities and innovate, partner and acquired as appropriate to deliver more value to our customers. We are excited about our 2014 plans and look forward to sharing our progress throughout the year.

With that, we’ll turn the call over to the operator to begin the question-and-answer session. Operator?

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). Your first question will come from the line of Mr. Steven Frankel from Dougherty & Company. Please go ahead.

Steven Frankel - Dougherty & Company

Good morning. Congratulations on a great quarter and year. Maybe Doug, you could start with this notion of large recurring revenue contracts like Pearson. Did you sign any more deals like that in the quarter or if you didn’t, what the pipeline look like potential deals for 2014?

Doug Shaw

Yes. Thanks for congratulating us. We are proud with where we ended the year. Yes, actually the pipeline on our Creative Professional business, particularly with our direct sales force is at all time high. So we’ve really built a nice portfolio or collection of leads and closing of a nice rate. One thing that we track is how many orders do we get over $20,000 on an annual basis; and that number is up significantly. So, and the vast majority of those are recurring kind of revenues. We absolutely signed a lot of additional deals, and acquisition of Pearson, particularly in Q4. It seems like people want to kind of I don’t want to say flush out their budget but they had some extra monies available. So we signed some nice large deals, reoccurring, don’t recognize them, most of them in that quarter happens throughout the whole year.

So, I know I’m not being too specific but I will say that that business now is running at about 50% reoccurring revenue base. Three years ago, about 10% of the direct business was recurring. So two things did happen with more and more is reoccurring and the pipeline is growing and growing. So John McCallum who runs that business is frankly doing a bang-up job for us.

Steven Frankel - Dougherty & Company

And you mentioned ISVs, one of the opportunities for 2014. Is that a product cycle function, so because Apple, Microsoft et cetera are kind of coming up to where they tend to spend again or is this just your general focus on that customer segment?

Doug Shaw

Yes. I think it’s two fronts Steve. We are definitely tied somewhat to product cycles, so Microsoft or Google or Apple or Oracle, these are large customers. If they come out with the new rigor of their operating system, a lot of times they want to support additional languages or different target markets, so will come to Monotype or companies like us to say great we want the typeface to support those initiatives. What’s also happening is we’re leveraging our e-commerce sites in our sales force more to go deeper into the ISV business. So last year for the first time, we started licensing ISV fonts to gain developers, to people doing IOS and Android games. And it’s sort of really nicely slope and this is something their sales force isn’t touch at all, it is relatively small order size. I mean this isn’t like a $50,000 ISV deal, this maybe a $1,000 deal that’s done online. So I think we are doing deeper down to the smaller ISVs that it just wasn’t economical for us to go after that.

Steven Frankel - Dougherty & Company

Okay. And any update on your penetration or attempted penetration in the Japanese auto market?

Doug Shaw

All I can say is that we had a real successful show in Tokyo, a lot of interest, a lot of people evaluating; nothing we can announce. So I think as explicit as we could be here as we talked about, we signed up nine manufacturers and eight tier 1 suppliers, most of these companies don’t want us to announce their names until they’re actually in the market.

Steven Frankel - Dougherty & Company

And where was that number, six months ago?

Doug Shaw

I am looking at John Seguin here. It probably is up, I would say at least 20%, 30%. So, it’s heading -- it’s absolutely doing what we expected. And we will make penetration into the Japanese market, we are -- just can’t talk about it.

Steven Frankel - Dougherty & Company

Okay, great. Thank you.

Operator

And your next question will come from the line of Mr. Richard Davis from Canaccord. Please go ahead.

Richard Davis - Canaccord

Hey, thanks. In terms of kind of royalties and the (inaudible) and when we look at kind of temporary results that has come out here or the preliminary results that have come out of some of the printer guys. Is it accurate to kind of say that we’re still kind of in that mid-single digits whether that’s 5% or 8% kind of unit growth as a logical expectation for the printer side of the house?

Doug Shaw

What we look at Richard is obviously we have the royalty reports and then we also look at what IDC is forecasting. And our internal plans of that 3% to 5%, frankly from a conservative standpoint, let’s make it 3% and then frankly only a good news or upside after that number, so like that in 3% to 5% on the printer side.

Richard Davis - Canaccord

Got it, and that’s helpful. Okay, thank you so much.

Doug Shaw

Sure.

Operator

Your next question will come from the line of Kevin Liu from B. Riley. Please go ahead.

Kevin Liu - B. Riley

Hi, good morning. I just had a couple of questions on the digital ad opportunity. You talked about some strategic funding to better understand the market; maybe if you could help kind of quantify those and then talk about the areas where that spend will actually be directed this year? And what sort of milestones do you hope to achieve over the course year, should we be looking for just announcements around standardization, and actual partnerships or are your goals a little bit more conservative than that?

Doug Shaw

Yeah, great question. I will say our goal is strengthening, not to generate much revenue this year in digital advertising, it really is what we would love to have happen is during this year to announce that we are partnering with XYZ company or companies that are on the four front of pushing HTML based ads which means web fonts outplay in that environment.

What's gratifying from our standpoint is you've got the Interactive Advertising Bureau, IAB organization gathering a lot of support within the industry promoting HTML 5 at that platform. It's not only the platform guys like Google and others, but it's also the -- it's a publishers who are on the forefront, companies like Forbes and Condé Nast and -- I don’t know, The New York Times. These are people that see real advantage in having HTML 5, having web fonts. And then you develop your ad one time and then it’s supposed pour right into these different environments. So, it’s quite responsive at the time.

So, I think a couple of really good things are happened. One, it's trending into a platform frankly, people are making money at, really more and more and more that Yahoo and Google and Facebook and the others, they see it as a important money generator. And that's a proof point. And what we think the next step is that advertisers as goes demand, I want my brand, I want my corporate looking feel. And that's where we come in there.

So, I know I'm rambling a little bit, but I think the punch line is this a year for us to put the right stakes in the ground, partner with the right people. In our mind, it's a no brainer, it's just a matter of when will it happen.

Scott Landers

Yes, just a quick add on to that. Kevin, this is Scott. Just to remind as sort of what -- the work we did with Web Fonts for website maybe 4 or 5 years ago, when we were articulating to the market, the investments that we're making. So, this really goes across the board, it's product management and engineering, as we get to understand the ecosystem and the technology that plays, fine tuning our solutions to make sure that we can help the creative work flow in the best way we can. There certainly is sales effort in building relationships with these major people who could be analyst for us to these partnerships and as well as marketing dollars and there are just general awarenesses within the marketplace of how important the brand is and its response of this (inaudible) world. So it is across the board.

Doug Shaw

And actually not so overly, label the font, but just to add a little bit. We are conversing on a push-pull strategy. So but the pull side is working closely with the platform folks. The push side is to work with always large corporations that really care about their brand that are already customers of ours for the desktop fonts, for the corporate websites and say, he, can we together convert the industry to make frankly web forts, HTML 5 fonts, et cetera. So traditionally we are really strong with the platform guys, now let’s say it leverage our sales force out there to work with the (inaudible) or whoever to really together promote this as a new standard.

Kevin Liu - B. Riley

Great. And just one question on the direct business, you guys talked about the big pipeline you are building on the software side are there plans to add more direct reps there or you guys are pretty comfortable with the size of the team already?

Doug Shaw

We’re adjusting to add more reps and we found, it is -- we've had a lot of success in our London office and now in the New York City office. And Frank in the old days what we do is put one or two sales people on these markets and then typically if the orders are coming and will expand, what we found out is the right thing to do is yes, you put those one, two sales people, but you also add typographers, marketing people, you create a team of like four, five people and that's become our model and that what we are doing is that's the model in New York, (inaudible) bigger map that's a model in London.

And then look at Berlin and look at San Francisco and look at different markets, where now we have this, the most synergies happened with this team that can go and deal with our customers. And our big fingers is strategic partnerships so how do we not just go on and pitch, a couple of fonts. It really is how do we help our customers be successful as they evolve into the digital world.

Kevin Liu - B. Riley

Great. Thanks for taking the questions and congrats on a strong quarter.

Doug Shaw

Hey thanks.

Operator

(Operator Instructions). And your next question will come from the line of Matthew Kempler from Sidoti & Company. Please go ahead.

Matthew Kempler - Sidoti & Company

Thank you. Good morning. So it sounds like that using portion of the incremental spend in 2014 is tied to the mobile advertising segment. Could you provide some perspective on the potential pay-off from this down the road, how big you view this opportunity as?

Scott Landers

Sure Matt, it’s Scott. So, we’ve talked about this in the past. As far as, what the opportunity could be for web fonts for websites that our hope that that business could one day be a $30 million to $50 million opportunity. And given the first few years that we’ve had it seems like we’re marching towards that range. As we look at the display ad opportunity we know that the volume of hit there is some sort of the multiple of that. So whether or not that is 2 to 1 or whether it’s 1.5 to 1, whether it’s 10 to 1, I mean you can be crazy with the numbers, but what we do know is that it’s substantial given the relative number of impressions that are going through. And in particular with the value that we can add by ensuring our brand consistency, our hope is that we can maintain as much as our value profits possible from a pricing perspective and that was carrying throughout the model.

Doug Shaw

Yes. And as we’ve talked about for format is. So our internal plan is we don’t know why it shouldn’t be 2x of what we have on the web font side, the corporate size. There is a notion to overcome the design community uses tools like flash and others and they’re very used to it. So now there is a whole education site, there is a whole toolset site and there are some things to overcome, things like latency how fast can all these ads to be sent on all over it, all of which we think we’ll overcome, but it is a transition kind of process versus a light switch process.

Matthew Kempler - Sidoti & Company

Okay, great. And then on the automotive side based on the design wins with OEMs and supplier that you have reached in 2013, do you have a sense of what Monotype share of the automotive market would be as these models were [allowed] over the next couple of years?

Doug Shaw

Yes, what shared before is that we get roughly $0.50 a car and our business as Scott mentioned has been on a nice slope and is still relatively small. So it’s in a 3 million kind of area. So, if you do the math that’s about 6 million cars off of I think there is 80 million cars a year. So, you can kind of do the math there.

We’re less than 10% penetrated today. What is gratifying is the names that we have shared in our contracts with GM and Ford and Chrysler, BW and Audi. So, I mean we aspire on all our markets to be 50% penetrated, that’s a high goal, but we should be well over -- our plans are to be well over that 10% for this year.

Matthew Kempler - Sidoti & Company

Okay. And then lastly on the PDL software, so you signed two Tier 2 OEMs in Italy so far, I was wondering if you could provide any update on the status of sales cycles for the Tier 1 OEMs? And are there any specific remaining hurdles that you see to the decision making process?

Doug Shaw

Yes, I think a significant walkers of all our [dungeons] frankly and I think a significant hurdle is that we offer what we think is a technically superior solution, but frankly our customers, a fair amount of them say what I have today is good enough and I’m concentrating on other areas. So, we think there is an opportunity of sales force continue to look at the kind of niche opportunities maybe even look at Tier 1s, but no news, it’s really those two accounts.

Matthew Kempler - Sidoti & Company

Okay. Thank you.

Operator

The next question will come from the line of Mr. Ross MacMillan from Jefferies. Please go ahead, sir.

Ross MacMillan - Jefferies

Thanks a lot. I joined over late, so I may have missed this, I apologize if I am repeating the question. But maybe first with Scott, you’ve done a great job in driving incremental gross margin this past year. I was curious as to where you think gross margins can go in 2014 and how we should think about long-term gross margins for the business as we move through this mix shift towards more CP revenue within the next?

Scott Landers

Yes, I think our target range of 82 to 83 feels right for now, I think that certainly has improved since the early days from right after we did the Midstream acquisition, so that feels good. What feels nice maybe to step back more holistically is that that business has transitioned to more and more Creative Professional, our margins have held very, very strong and I think that was something that people didn’t think responsible. And again, it goes to this core value prop that we have and its core of what we are doing is leveraging that font IP that we own, ramping new technologies around it and bring it to new markets.

So, I think for the shorter term here I think that 82% to 83% target range feels good. And then such things change down the road and maybe we can echo a bit more out of it, that’s possible, but generally not in the short-term road map.

Ross MacMillan - Jefferies

That’s helpful. And then you may have talked about this, the deferred revenue was weaker than we expected in the quarter and was down year-over-year. What’s the driver for that?

Scott Landers

Yes, our deferred revenue isn’t like typical deferred revenue where you have a bunch of backlog of maintenance contracts. We get a lot of variability based on OEMs who make you a free payment of royalties for us and those can vary year-to-year. So, you could see a few million dollar swing and it's not indicative of any backlog of customer commitment from a customer prepayment.

Ross MacMillan - Jefferies

That's helpful. And then just Doug or Scott, I guess two things. One is when you think about web fonts -- let's talk about the CP business today -- for 2014. If you think about web fonts within the mix, have you updated any targets around that? And then another comment would be what do you think about the mix between the recurring and highly predictable part of CP versus the non-recurring part in 2014?

Doug Shaw

So yes, we have pulled the market for this year. Our internal goal is to generate $17 million in web fonts up from $12 million last year. About two-thirds of that Ross is recurring SaaS model, one-third of it is on a more of a perpetual basis. And what we like about that is the major brands are going for the SaaS model, it's for typeface like (inaudible) the most popular branding fonts. And then the smaller companies which maybe a less tied into the more historical brands are going forward for frankly less page views and we're able to I think makes penetration on the bottom of the pyramid as far as uses of web fonts.

Across both businesses, both e-commerce and direct sales I think they are seeing similar growth rates when it comes to web fonts. So, I wouldn't say one is more dominant than the other. Pricing models are holding up.

Ross MacMillan - Jefferies

Yes, I guess the question I really had was if we take CP in entirety and we split between recurring and highly predictable and non-recurring, what do you think that mix looks like in 2014?

Scott Landers

Yes, so Ross just to give you high level sketch, so what, if you look at Creative Professionals business we know that about two-thirds of it comes from our e-commerce side and one-third of it comes from our direct sales force. We said that that direct sales force is about 50% recurring as a point price and the rest would be really not predictably kind of -- it again, right.

On the e-commerce side, we would consider all of that revenue predictable. These are high, high volume low dollar transactions, which we know aren’t very sensitive to economic conditions, we now have our proof points from 2009 and how that business did waver very much during the recession.

So overall, the entirety of the CP business would be 85ish percent plus recurring and predictable or more heavily on the predictable side. We’re building a stronger recurring base overtime. When you are look at our OEM business it’s just the opposite. It has much more of the recurring nature to it with the smaller amount of predictability, but in total, still at that 85% level. So both of our businesses run about at 85% target, but they get there in different ways.

Ross MacMillan - Jefferies

That's really helpful. That's really great color. Maybe last one from me for Doug. As you think about digital advertising, you’ve historically had a really good relationship with big brands and agencies for traditional print form usage. And there have been a business model for that. As you think about moving towards true web fonts and then into digital advertising, obviously you are going to become a bigger cost to those companies, brands and agencies. And I am just curious as to how you sort of think about addressing that cost versus higher return for the customer? How do you sort of bridge that if you will with the customer as you speak to them? How do you think that will progress and how much added value do you think your new solutions can provide so that the cost is palatable?

Doug Shaw

Yes. I think you hit at the very end to of your question, Ross. It really is all about the value. So, our strategy has been to not only offer our tier work site is like over a 150,000 different fonts on there, but not only offer a huge font selection, but also offer workflow tools, so the Typecast application, things like SkyFonts which will help sync your fonts across all of these platforms. We’ve talked about our roadmap for Typecast as today we think it’s a fantastic environment to do corporate websites, we also think that it could be very helpful from workflow standpoint to do digital ads, to do email marketing. So if you want a greater looking type product in these platforms, work with Monotype, we’ve got the tools, we’ve got the font IP, we’ve got the sales force, we have the expertise. So it’s all about trying to transition from not just going to our website and paying $25 to download it to your desktop, it really is, well, I’ve got some challenges on my business, have some opportunities, Monotype can help me to get there. And at least our proof point on Web Fonts is we’re getting minimal pushback on that $0.04 per 1,000 page downloads and that’s exactly the model we’re going to with higher volume markets like digital advertising. Real world though, if digital advertising ends up being a 4, 5 times the kind of volume that we see today in corporate website, I am sure there will be some pushback but we’re not there yet.

Scott Landers

Yes. I would just add to that. I mean there is a one line in script that we are investing and understanding the ecosystem. So, it seems like a very simple line but that is a huge investment and a very big strategic statement for us. And one of the things that I am really pleased with is if you look at a Typecast acquisition where it can help us get deeper into the workflow, just having those people onboard, the discussions we have in how much further we can go down the workflow and how many problems we can potentially solve down the road is pretty exciting for us. And to your point Ross, I think that’s going to be important as we add as much value as we possibly can to these brands as they take it through the digital world.

Ross MacMillan - Jefferies

That’s very helpful. Thanks a lot and congrats.

Doug Shaw

Hey thanks.

Operator

Your next question comes from the line of Saket Kalia from JP Morgan. Please go ahead.

Saket Kalia - JP Morgan

Hey guys, thanks for taking my questions here. A few, if I may. Hey Doug, one of the four focus areas you mentioned for 2014 was ISV. So I guess the question is what sort of opportunities do you see this year for it? And would it kind of continue to be mostly service oriented?

Doug Shaw

Yes. I think that -- I mean there is a revenue component, so we do think that it can grow that high single digits, maybe double digit growth rate and we’ve got plans there. But frankly more importantly is to some degree these people I’ll say control our lives but what Microsoft, Apple, Google, Adobe, companies like this, what they do with Type, who they partner within the Type industry as they further business initiative is crucial to that answer would be Monotype, that we want these folks to turn to us, to be their partner as they break into new markets. So, we’ve done some reorganizing within company, our (inaudible) is on the point here, has great business relationships with these folks. So, it really is a more in-depth focus of where are they going, how do we make sure we’re there frankly for the ride, and to figure out that where they see opportunities, great. Okay, we want to be there as the font supplier, not only for them but frankly more importantly to the market they’re serving. It’s been a model we kind of informally used for years and now we are trying to be able to more structured about.

Saket Kalia - JP Morgan

That’s great. And then next. It’s not to mention the $3 million in auto revenue this year, where do you see that going in 2014, is that something making double or perhaps more, how do you see the growth trajectory there?

Scott Landers

Yes, we are not giving specific growth guidance per device, but we’re certainly, we think we’re in the early days in it. So we’d be disappointed if didn’t see nice growth. I think as you heard us talk about our device categories in the past that our device category would be meaningful with the effect to the size of $10 million range as that $3 million we’re certainly getting close and our hopes would be that we can get there soon.

So that’s as much as I would say at a detailed level, Saket. This remind us with some other devices what I could see years ago, so you have some additional accounts to begin to give some design wins with several other major manufacturers and now we hopefully accelerated the start. If we can begin to broaden out with each account and then tack on a few more manufacturers as you go.

Saket Kalia - JP Morgan

That’s helpful. And then lastly on Web Fonts, as that market has become kind of more established, are you seeing any change kind of on the competitive landscape there?

Scott Landers

Yes, I don’t think so. I think we have always been realistic about the markets that we serve and the markets that other folks serve. So, if you think about the very highest end of the pyramid, I think we've had a really solid foundation with that fraction of the market in the beginning and through today and certainly into the feature. I think it was always a big section, it’s the largest section of that market, which was kind of the free one, right. And then kind of Google always had it and probably always will and that's where we've done, I think some smart things in partnering with Google and trying to roll over the people that go to Google site who really aren't in the mood for free fonts, and want more of a branded experience.

And I think probably the best thing we ever did was taking a look at that middle section of the market through the Bitstream acquisition and the MyFonts site really helps us address that middle slice like we couldn't have done on our own. So, obviously that's going back probably year and a half now. But now that the highest end where our Fonts.com site would be positioned holding strong, the MyFonts site doing terrific and then the rest is really for Google.

Doug Shaw

Yes, I think what's nice about the position we have is of course we have competition, particularly in non-Latin speaking markets, but even in U.S. and Europe. But what the Bitstream acquisition as Scott mentioned, we're big on this crowd sourcing initiative and we really just tell the industry, yes you could have your own website if you want. You can go through the expense and then try to have as much traffics on to it or just send your IP to us and price it however you want and run and we have the ability to use your special marketing programs, we can give you daily reports as far as sell through. So, we've done a really good job I think of having our arms wide open to the industry. And then of course we have our own site Fonts.com and our direct sales force to be pushing Monotype IP. So, I think we'll go put in each camp and have been able to navigate through that.

Saket Kalia - JP Morgan

Got it. Thanks very much.

Operator

And your final question will come from the line of Steven Frankel from Dougherty & Company. Please go ahead.

Steven Frankel - Dougherty & Company

Scott, could you tell us why the gross margin popped a little bit in Q4 and why that won’t reoccur in 2014?

Scott Landers

Yes, every now and again we can have anomalies like that Steve. And one of the things that's driver of our gross profit margin, certainly the cost that we would have externally, either royalties that we pay, or either contractors that we pay who are working on behalf. The other thing that impacts that line is what are our engineers working on, are they working on internal projects or are they working on customer projects.

So from quarter-to-quarter, you could have a margin that perhaps looks a little bit better and that's because they’d be more -- less work was done by our engineers on third party -- I’m sorry, customer projects versus internal projects. And so that can shift which is why we’re not forecasting that to go forward put it you. It’s basically a reallocation in R&D and cost of sales.

Steven Frankel - Dougherty & Company

Great, thank you.

Operator

And we have no further questions at this time. I will now hand the call back over to Mr. Doug Shaw for closing remarks.

Doug Shaw

Okay. Well, thank you for joining us today. We appreciate your continued support in Monotype. In summary, we had an excellent fourth quarter and full year. 2013 was a year of innovation and accomplishments as best we executed against our strategic priorities. We are looking for more the same in 2014. Thanks and have a great day. Take it easy.

Operator

Ladies and gentlemen, this concludes the conference call for today. Thank you for participating. And please disconnect your lines.

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