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Bitstream Inc. (NASDAQ:BITS)

November 11, 2011 8:00 am ET

Executives

Scott Landers - Chief Financial Officer, Principal Accounting Officer, Senior Vice President, Treasurer and Assistant Secretary

Staci Mortenson - IR, Integrated Corporate Relations

Amos Kaminski - Executive Chairman, Interim Chief Executive Officer and Member of Special Committee

Douglas J. Shaw - Chief Executive Officer, President and Director

Analysts

Ralph Schackart - William Blair & Company L.L.C., Research Division

Saket Kalia - JP Morgan Chase & Co, Research Division

Matthew J. Kempler - Sidoti & Company, LLC

Richard H. Davis - Canaccord Genuity, Research Division

Steven B. Frankel - Dougherty & Company LLC, Research Division

Ross MacMillan - Jefferies & Company, Inc., Research Division

Operator

Ladies and gentlemen, welcome to the Monotype Imaging conference call on the 11th of November 2011. [Operator Instructions] I will now hand the conference over to Staci Mortenson. Please go ahead, madam.

Staci Mortenson

Thank you, and good morning, everyone. With me this morning are Doug Shaw, President and Chief Executive Officer, and Scott Landers, Senior Vice President and Chief Financial Officer. Today, we'll review the acquisition of Bitstream's font business, which we announced following the close of markets yesterday. We will then open up the call for questions.

Before we begin, I'd like to remind everyone that matters we're discussing today and the information contained in the press release announcing the acquisition of Bitstream's font business that are not historical facts are considered forward-looking statements within the meaning of the Private Securities Litigation Act of 1995. Forward-looking statements including predictions, estimates, expectations and other forward-looking statements generally identifiable by the use of the words believe, 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 opinion only as of today's date, November 11, 2011. 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 revisions of forward-looking statements on this morning’s conference call other than through filings that may be made with the SEC concerning the matters discussed on this call.

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.

In addition, a link to today's call can be found under Events and Presentations in the Investor Relations section of our website at www.monotypeimaging.com. This call will be archived on our website.

And now I'd like to turn the call over to Doug Shaw. Doug?

Douglas J. Shaw

Thank you for joining us this morning to discuss our exciting news that Monotype Imaging has entered into a definitive agreement to acquire Bitstream's font business. I will provide an overview and the key strategic reasons behind our intent. Then I will pass the call over to Scott who will review the details related to the post structure of the transaction.

Monotype Imaging combines technology with design to help the world communicate. Today, we are a leading provider, global provider of text imaging solutions with fonts and technologies that enable the display and printing of high-quality digital content.

We have successfully grown our business organically into acquisitions. The acquisition of Bitstream's font business is clearly in our stated strategy of expanding IP, growing our customer base, capturing emerging opportunities and increasing momentum in our growth businesses.

The transaction will include Bitstream's popular MyFonts.com website, which features 89,000 fonts from nearly 8 -- from nearly 900 foundries. The MyFonts site also includes the widely used WhatTheFont service, which helps customers identify fonts. It uses post and image to WhatTheFont to find the closest match in the database, while the font enthusiasts lend a hand in the WhatTheFont form.

The acquisition will also include the Bitstream Typeface Library the company's font fusion and panoramic font rendering and layout technologies in addition to fonts from embedded and mobile environments and 10 patents.

Bitstream is based in Marlborough, Massachusetts, and employs some of the most respected and talented professionals in the type industry. Approximately 15 people are expected to join us from their U.S. operations. We also anticipate that about 40 [ph] engineers and type designers will join us from Bitstream's development facility in India.

We believe the addition of Bitstream's expertise will further our ability to provide broad-based development resources to our OEM in greater professional businesses.

While Monotype Imaging and Bitstream are both font-focused businesses, they are based on complementary approaches. Classic historic type faces in multilingual offerings are at the heart of our product portfolio, where our strength is in targeting the needs of corporations and brands. Bitstream, on the other hand, serves a broad base of customers by way of new and distinctive type faces. We believe the combined entity will create market diversity that ultimately enhances choice for customers while fostering a creative community.

Through its MyFonts site and WhatTheFont service, Bitstream has cultivated an active, creative community, helping to drive exciting, innovative design. We believe that this community is a true asset to the font industry.

Bitstream also delivers an excellent online user experience and gives typeface designers considerable control over their work and business. It is our intent to maintain MyFonts.com with an eye towards supporting and extending the best aspect of MyFonts within our e-commerce and cloud-based offerings.

Bitstream's OEM business will bring to Monotype Imaging experienced professionals and a complementary customer base that match directly into the markets we serve, particularly in display imaging. The acquisition opens opportunity to expand within Bitstream OEM accounts to provide additional value while adding depth to our already strong family of OEM products and services.

Overall, the addition of Bitstream provides opportunity to grow our customer base, expand our IP and capture emerging growth opportunities, particularly in Webfonts services and our display imaging businesses. We believe the Monotype Imaging's global reach and financial strength, combined with Bitstream's e-commerce website and OEM business will create an even stronger company, one that is well-positioned to serve broader markets while addressing an even wider range of customer needs. With that, I'll turn the call over to Scott.

Scott Landers

Thank you, Doug. Starting with the terms of the agreement. Monotype Imaging has agreed to acquire the outstanding shares of Bitstream, which at closing will consist only of the company's font business. Consideration will be $50 million in cash, subject to closing adjustment. The transaction has been approved by both companies' boards of directors and is subject to Bitstream shareholder approval and the completion of customary customer conditions. The transaction is also contingent upon Bitstream's spinoff of its mobile browsing and variable data publishing businesses. The details regarding the spinoff can be found in the S-1 filed yesterday with the SEC on behalf of the new entity.

The acquisition is expected to close at the end of the first quarter of 2012. We intend to finance the transaction through a combination of our cash balance and revolving credit facility. As a reminder, we ended the third quarter with $51 million in cash and in a net cash position.

The acquisition makes sense from both a strategic and financial perspective. Bitstream's font business is growing and profitable. According to Bitstream's SEC filings, we estimate the business we intend to acquire had a revenue of approximately $17 million in 2010. We anticipate the majority of revenue will be included in our creative professional business.

We expect the deal to be accretive to net adjusted EBITDA and non-GAAP EPS within the first year of closing including nonrecurring acquisition-related cost.

At closing, we will provide more detailed financial guidance and other key items related to the operations as a combined entity. We're very excited about this acquisition and believe it will help accelerate our growth and strengthen the value we bring to the design community.

Now we would like to turn the call over to the operator for the question-and-answer session. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] The first question comes from Saket Kalia from JP Morgan.

Saket Kalia - JP Morgan Chase & Co, Research Division

So first, Scott, what's the growth on that $17 million to the extent that you can disclose? I guess, '10 now over '09 and prior years if possible? And then I'm assuming with around 55 total employees that are coming in, is it fair to assume that the margins on that business are similar -- are pretty similar to Monotype's?

Scott Landers

Unfortunately, Saket, we can't give any -- other details regarding financial guidance or even looking back historically any detail growth projections. What we do know is we're excited about the acquisition, we think it's complementary and we're excited that it's a nice new chunk of revenue that is profitable.

Douglas J. Shaw

Yes, and also what else I can say from a high-level standpoint is I think we have a good track record of when we do M&A within the font industry, we really know the business very well and we know how to run a type company. So we think that this frankly will be a spectacular acquisition for us long term. Of course, the first year will be certain things. We have to write up certain revenues and from a deferred-revenue standpoint. But over the long run, this will be a big winner for us.

Saket Kalia - JP Morgan Chase & Co, Research Division

Okay. Maybe strategically, Doug, you can talk about on the Webfonts side. Was the acquisition really more to acquire additional typefaces to bolster the offering that you have on Webfonts or what else does it offer on the Webfonts side?

Douglas J. Shaw

Yes, what it really offers is -- it became clear to us let's say, 2 years ago -- maybe we're a little late catching on, so maybe a year ago that MyFonts had really developed a community following with their website. We're very proud of what we do with fonds.com and the great revenue in growth. We're the place to go when you want those branding fonts, those classic fonts. What MyFonts did to their credit is they were the place to go if you're a hot designer and you want to get your font out there and you actually kind of control to a certain extent how that font is promoted to the market. And they actually create a community where people now tell their friends to put -- to post their fonts up there. So they created this environment where the new young innovative designs are showing up on that site. So what we love about it is when you look at the 89,000 or so fonts on the site, an awful lot of them we don't carry in our site. So it does bring additional IP, it also brings buzz. It's frankly -- it's kind of a cool place to be if you're a type designer looking for fresh designs. So it's kind of a long answer but yes, we think it will bolster not only our traditional desktop but definitely on Webfonts service. It gives our users more selection.

Operator

The next question comes from Matthew Kempler from Sidoti & Company.

Matthew J. Kempler - Sidoti & Company, LLC

So I guess, I'd start off with the Bitstream business as far as the industry I understand has been up for sale for about 1 year or so now. So what led you to consummate this deal today?

Douglas J. Shaw

When we heard that over a year ago that they had hired an outside adviser to look at strategic alternatives, Dan Garren [ph] who heads up our business development group, he contacted them and it took a little while but eventually they sent us some information about the company. Frankly, I'll just speak for myself, I was surprised about their font business. I was particularly surprised about how well their MyFonts business has done. They don't disclose this within their public filings. So once we understood what was going on with that business and their OEM business, we became very interested, but frankly, only in those [indiscernible]. So we have no interest in Pageflex and BOLT, their 2 other businesses. I think that the market will judge the value of those products, that there seems to be a certain amount of interest there. But we wanted to stay core to what we do, which is text. So it took a long time because they looked at other alternatives, particularly for the other businesses. I think I read in one of their filings that there were 90 people that were notified as far as interest in Bitstream's entirety or in their parts and finally, they decided the best thing to do was for BOLT and Pageflex is to spin those off, and that process has took a while. So I'm sure it took longer than anybody had thought but we're a patient company and we do it in the long run, it was our customers' best interest.

Operator

Matthew Kempler has disconnected unfortunately. We'll move on to the next question from Steven Frankel from Daugherty.

Steven B. Frankel - Dougherty & Company LLC, Research Division

What about the customer base at MyFonts? How large is it?

Douglas J. Shaw

I actually don't know the answer to that, yet. It's -- I know during their quarterly filings they would talk about more and more users and all the rest. So all I can say, Steve, is that it's on this nice slope and I don't know the specifics but it was growing at a significant rate.

Steven B. Frankel - Dougherty & Company LLC, Research Division

And you probably describe how -- why their fonts are different and from a different class of designer than you typically serve. But do you think there's a lot of customer overlap or do you think because of those distinctive fonts, they really reach a younger hipper consumer or designer that you don't typically serve?

Douglas J. Shaw

Yes. I'm sure there's definitely some overlap. But, yes, when we look at the demographics of who buys from their site versus our site, they definitely had captured the minds and soul, so to speak, of a hipper crowd and -- who wasn't afraid to try kind of leading-edge typographic approaches. So, yes, they were definitely gaining momentum on the younger designers.

Steven B. Frankel - Dougherty & Company LLC, Research Division

And are their fonts priced similarly to yours or because of this arrangement with the designers, they have some kind of different pricing paradigm?

Amos Kaminski

It ranges but by and large, it's right in the same ballpark as us.

Operator

The next question comes from Ross MacMillan from Jefferies & Company.

Ross MacMillan - Jefferies & Company, Inc., Research Division

You mentioned most of the revenue will go into the creative line. But you're buying font fusion and panorama and other things here, which are IP-based. And I was just curious as to tying those 2 pieces together, getting a sense for why this is a lot more weighted towards the CP business.

Douglas J. Shaw

No, that's a fair question. So MyFonts was the initial thrust and was our -- what started our interest. As we peel back the onion, they have a nice OEM business as well. It's almost exclusively or primarily of the display imaging space. Things like Font Fusion and Panorama do similar things to our iType and WorldType Layout manager. We do think there's components of each technologies that could be interesting. So once we're allowed to really work with their engineers, our plan is to do best in class. Of course, we'll be supporting their existing customers and make sure they're happy with the products they have licensed. Over time, we'll look at what each technology does and do what we think is in the best interest of the customers.

Scott Landers

Ross, I would just add, it also -- as you look at it from a high level, it helps from the diversification perspective, as we're adding 2 components to both of our growth businesses and CP and then the deployment and component of OEM.

Ross MacMillan - Jefferies & Company, Inc., Research Division

Okay. And then my other question was on the typeface library. I guess, you typically license to others and maybe they to you. So I'm presuming there's some sort of net effect here where you won't pay Bitstream anymore for typefaces from their library and likewise, they won't pay you. And I was curious as to whether that's a net positive or a net negative in aggregate and just any sense for materiality there?

Douglas J. Shaw

Yes, that's a fair question. Over the years, there has been some cross-licensing of libraries. The last couple for whatever reason, there hasn't. So they're not a big reseller of ours, we're not a big reseller of theirs. But we do work occasionally on a per customer basis. So -- but there is no large revenue stream in either direction between the 2 companies.

Ross MacMillan - Jefferies & Company, Inc., Research Division

And then just last one for me. Just going back, I guess, to customers look more on the IP side against the display side. Do you have a sense as to whether Bitstream had a number of customers that you simply didn't have on the display side? Is that a net addition or do you, as you look to that, you think there's a lot of commonality on the customers on the display side?

Douglas J. Shaw

That's a good question. We do have a couple of joint customers, but truly it's a couple would be -- I think it's like one hand, is that even the total. When we look at their customer base, it is almost exclusively complementary. They have done a good job in some initiatives they've talked about in their earnings call, the TV market and other -- I think medical is one they have made some progress as well. So when we look at their customer list, a lot of them were ISVs. Some of them of them are -- make mobile devices and other CE devices. So it's almost I'm going to say 95% complementary.

Ross MacMillan - Jefferies & Company, Inc., Research Division

And then very last one for me just on the -- I know you're not saying a lot about financials but it appears that you're going to be acquiring about 1/3 of the employees at Bitstream, kind of pre-existing employees? So from a cost -- and many of those aren't offshore. So from a cost perspective, is that a fair way to start thinking about it?

Scott Landers

Yes, I think it is. We can't give, again, the specifics, Ross. But that's one of the reasons why we broke out where the employees were located just because there is a difference in economics.

Douglas J. Shaw

Yes. And maybe just one other point on that. The one thing that we were also surprised about, once we dug into the company is having this Indian office could turn into a really, really nice thing for the company. We're sending some people there in 2 weeks to learn more about their operation but the way it's been presented to us is really bright engineers, hard-working engineers expertise not only in type but in other areas. They have very attractive cost structure. And so -- and run by a really strong general manager. So frankly, we've always wanted to have an Indian offshore-ing source but we didn't know -- we had to consider doing it ourselves, start from scratch or to this vehicle. So this could end up being a really nice kind of hidden advantage to us, where we can put more and more of the things we do in this building over there. A lot of the things in the innovative side as we look to broaden beyond our tech solutions. So it gives us more flexibility, I think, is probably the best way to position it.

Ross MacMillan - Jefferies & Company, Inc., Research Division

But just to be clear, I guess, [indiscernible] it's from your $17 million number, that's over 70% of revenues and you're taking about 1/3 of the employees. Is that -- that's where I was really going with that.

Douglas J. Shaw

We are but, boy, don't divide their total expenses by 1/3 and say this is what [indiscernible] this Indian office is very attractive from our cost structure.

Operator

The next question comes from Matthew Kempler, Sidoti & Company.

Matthew J. Kempler - Sidoti & Company, LLC

I got dropped before. Sorry about that. So if these questions were asked, I'll [indiscernible]

Douglas J. Shaw

I didn't think you liked the answer, Matt, so you just hung up on us.

Matthew J. Kempler - Sidoti & Company, LLC

Let me just ask. I know you're not giving up the financial details but you were $50 million which seems like it's going to be 2.5 to 3x revenue range. As far as I understand, it's not largely recurring and it appears to be lower margin business. So can you just talk about the returns internally that you're targeting with this acquisition?

Scott Landers

Matt, I'd rather not get into the specifics but I will speak to what we're buying in the recurring nature. So there is the one component of it that is OEM and that follows a similar profile. Our own OEM business as you know, is highly recurring in nature. And then as we look at the web, I mean, I know when we look at our own business, we looked at it -- look at that as a recurring revenue stream. It's high volume low dollar transaction where you had built an awful lot into the brand where people are coming to your site because they want to and not a lot of -- you don't have to do a lot of pushing or pulling to get them there. So I would characterize both of those streams as some highly predictable without standing customer basis in which to draw from not only currently with the offering but as we look to offer more value to those customers.

Douglas J. Shaw

And maybe just to parlay that one. Matt, I know when you look at our creative professional business, although half of it is on our website, half of it is our outbound sales force. And that outbound sales force have to earn the order every day. And that business, as you know, is in a really nice uptake the last couple of years but it also is accounting for a certain amount of lumpiness in our business. They don't have an outbound sales force when it comes to creative threshold. It is 100% web. So I agree with Scott that, that feels like reoccurring a lot of an analytics. And the OEM, a lot of them are annual reoccurring revenues or royalty base. So in some ways, their business is more reoccurring than ours.

Scott Landers

I would just add to what Doug said, I think, maybe on the first question. We are a type company and we've got a track record of acquiring other type companies and doing really great things with them. And this one is smack in our wheelhouse and we think will be very helpful as we move forward.

Matthew J. Kempler - Sidoti & Company, LLC

Okay. And then regarding the margins, it appears that they have a lower gross margin than type. I know you can't comment on that specifically but my understanding is a higher portion of their sales were third party and that's part of -- and the royalty they paid that's helped -- that' what partially has dragged down their gross margins. From your perspective, once you operate this business, would you potentially look at cutting back on third-party sales or do you think your scale that you have can actually help reduce the royalty payments that might help your -- the margins on this business?

Scott Landers

Unfortunately, we really can't touch on any of that. What we do know is that when we combine 2 type companies, there's a lot of good things that can come from it, but I can't speak at all with specifically any of their financials.

Matthew J. Kempler - Sidoti & Company, LLC

Okay. And then the last question, you mentioned OEMs. Have they made any inroads at all in the printer segment? Does this help your business market share?

Douglas J. Shaw

Yes. They have a handful of printer accounts in Europe is the ones we know mostly about. I don't think it really helps our printer business at all. They've always been our opinion, been kind of a niche player there and well, we don't see it as a win on the printer side, it's much more in display imaging and our creative professionals.

Matthew J. Kempler - Sidoti & Company, LLC

Okay. Are there any other major display imaging technology vendors out there at this point?

Douglas J. Shaw

When it comes to fonts, you mean?

Matthew J. Kempler - Sidoti & Company, LLC

That's right. When it comes to the font side, what you guys are doing, fonts and font rendering.

Douglas J. Shaw

Sure. Okay. Absolutely. When we look at around the world, there's a lot of Asian suppliers, there's a lot of boutique suppliers. So we absolutely see broad competition in both the end-users space and the OEM space. Just one note on the end-user side, creative professional side, I think we all know that Adobe recently bought a type company called Typekit. And so they will be getting more involved from the type business. Google actually offers a web font services offering so it's kind of interesting that type seems to be hot these days and more and more people are getting into the space.

Operator

The next question comes from Richard Davis from Canaccord.

Richard H. Davis - Canaccord Genuity, Research Division

Just 2 quick questions. The first is on WhatTheFont business model. Is that a paid for service or is it just a tool to get consumers and publishers to license more e-commerce funds?

Douglas J. Shaw

It's the second. It's a 3 offering -- and what they've done, again, we have to give them a lot of credit. It's -- someone takes a picture of a font with the iPhone or scans it and sends it to WhatTheFont and it takes it's best guess as far as what the typeface is and it gives it a certain rating. 86% chance it's Bodoni. And if it can't figure it out, it throws it out to the community. And then there are dozens if not hundreds of people who kind of say no, no, no it's Bodoni, it's something else. And to get this kind of buzz going on with the world trying to help somebody else as far as what the typeface is. And then once it's identified, a lot of times people say, I want to buy it. What's happened frankly, is it sends a lot of traffic to their site. So it's a patented technology and is a really valuable tool for the creative design.

Richard H. Davis - Canaccord Genuity, Research Division

Got it. And then just secondly on the processes, was this a competitive business? Are there other bidders for the font business?

Douglas J. Shaw

Yes. To our knowledge, there were 90 people that were contacted and some way or fashion for the Bitstream company in total. When it comes to the fonts specific, we really don't know but I'm sure there are other people interested. I would say we were the natural acquirer once we understood better what their business is.

Operator

Your next question comes from Ralph Shackart from William Blair.

Ralph Schackart - William Blair & Company L.L.C., Research Division

You talked a lot about Bitstream business holding into creative professional. But just curious, Doug, on the IP side, do they have any IP that was underutilized or that you can with your leverage and strength and market leverage more so on a go-forward basis either in terms of new products or going deeper with existing customers?

Douglas J. Shaw

Yes, I think they did. So one of them is they have a significant index typeface library in growing. We have a fair amount of Indic typefaces but not as many as they have. And clearly, that Indian market particularly in the mobile space is such an exploding market opportunity. They also have certain verticals. They have a typeface called Tiresias that is important in certain standards of bodies. And frankly, what they have is a handful of really, really smart engineers. So one person joining us is Stampo [ph] and Stampo [ph] holds the patent on true type. So he and others when they were at Apple, they actually developed the true type rasterizer. So John Collins is the one who has been the mastermind and John and his team up to MyFonts and John should be joining us. So we're getting some really smart type people who frankly, we like and I think are excited about joining the company. So they've got IP today and we're expecting them to turn out a lot more in the future.

Operator

[Operator Instructions]

Douglas J. Shaw

So, operator, I don't think there's any more questions.

Operator

So there are no further questions at this time, sir. Please continue.

Douglas J. Shaw

Okay. So I just want to thank everybody for joining us this morning. We appreciate your interest and we look forward to giving you a lot more details at our next call. Thanks a lot and have a good day.

Operator

This concludes the Monotype Imaging conference call. Thank you for participating. You may now disconnect.

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Source: Bitstream Inc., Monotype Imaging Holdings Inc. - M&A Call
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