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

| About: Bitstream Inc. (BITS)

Bitstream Inc. (NASDAQ:BITS)

March 20, 2012 8:00 am ET

Executives

Staci Mortenson - Senior Vice President

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

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

Analysts

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

Barbara Coffey - Brigantine Advisors

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

Saket Kalia - JP Morgan Chase & Co, Research Division

Matthew J. Kempler - Sidoti & Company, LLC

Operator

Ladies and gentlemen, welcome to the Monotype Imaging Complete Acquisition of the Bitstream's Font Business Conference on the 20th of March, 2012. [Operator Instructions] I will now hand the conference to Staci Mortenson. Please go ahead, Madame.

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 will review the acquisition of Bitstream's font business, which we announced following the close of the market yesterday. We'll 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 Reform 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, March 20, 2012. Information on potential factors and detailed risks that could affect the company's actual results of operations is included in filings made with the SEC by Monotype Imaging and Bitstream. The company undertakes no obligation to revise or publicly release the results of any revision to the forward-looking statements or on this morning's conference call other than through the filings that will be made with the SEC.

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 further complement to our results provided in accordance with Generally Accepted Accounting Principles. A reconciliation of these non-GAAP measures can be found in our press release issued yesterday.

In addition, a recording of today's call can be found under Events & Presentations in the Investor Relations section of our website at www.monotypeimaging.com. The call will be archived on our website for one year. 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 completed its acquisition of Bitstream's font business. I'll start with a brief overview of the key strategic reasons behind the transaction and then pass the call over to Scott. He will provide financial details including an update on guidance.

Our mission is to be the first place to turn for typefaces, technology and expertise that enable the best user experience and ensure brand integrity regardless of device, platform or language. We've successfully grown our business organically and through acquisitions, and we believe that acquiring Bitstream's font business will strengthen our ability to deliver on our mission and to better meet customer needs. The transaction includes the popular MyFonts website, Bitstream's typeface library, the company's font rendering and layout technologies, fonts for embedded and mobile environments and 10 patents. We've also gained new customers such as Cox Communications, WebEx and QNX.

Turning to MyFonts. We see significant value in this online store, which features 89,000 fonts from nearly 900 foundries. Through MyFonts, Bitstream has fostered a dynamic creative community. The site offers cutting-edge designs that complement our classic historic fonts used by corporations and brands. In addition, MyFonts features the unique WhatTheFont service, which helps customers to quickly identify typefaces. MyFonts has also made successful inroads within the Web fonts market, where MyFonts' customers are able to use self-contained kits that can be easily uploaded. Customers are therefore able to self-host Web fonts and not be dependent on external services.

Finally, the MyFonts site provides an excellent user experience and allows foundries to easily promote their fonts and access sales reports in real time. It is our intention to put more resources behind MyFonts with an eye towards supporting and extending the best aspects of MyFonts within our e-commerce and cloud-based offerings.

Turning to OEM. Bitstream's OEM business brings to Monotype Imaging a complementary customer base that maps directly into the markets we serve, particularly in display imaging. We expect to expand within Bitstream's accounts by providing additional value while adding depth to our already strong family of OEM products and services.

Further, we're excited to welcome some of the most respected and talented professionals in the type industry. As of today, 13 people have joined us from Bitstream's U.S. operations. We've also gained our first development and R&D center in India, which is staffed by 42 engineers and type designers. Along with a host of talented associates, we're thrilled to welcome industry leaders, including Sampo Kaasila, John Collins and Kevin Woodward. Sampo is an industry veteran who worked at Apple as the lead engineer and inventor of TrueType font technology. John has developed numerous type composition and font rendering systems and has been the key driver behind the MyFonts business. Kevin is the creator of WhatTheFont, as well as the custom font rendering software used in MyFonts. We expect that the addition of Bitstream's expertise will further our ability to provide broad-based development resources to our OEM and Creative Professional businesses.

With that, let me turn the call over to Scott. Scott?

Scott Landers

Thank you, Doug. Starting with the refresh on the deal terms. Monotype Imaging acquired the outstanding shares of Bitstream for approximately $50 million. We funded the acquisition through a combination of cash on our balance sheet, as well as drawing down $25 million on our revolving line of credit. In addition to the strategic rationale Doug highlighted, I would note the transaction has another benefit: diversification. Post closing, 40% of the combined companies' revenue is derived from the printer space, with 60% coming from the growth businesses: Display Imaging and Creative Professional. Approximately 80% of the business we acquired relates to MyFonts, which will be classified as Creative Professional revenue, and the remainder is expected to be classified as OEM, with a heavy focus on the display imaging space.

In year 1, we will be absorbing integration and closing costs, as well as aligning revenue recognition policies and writing down the deferred revenue associated with purchase accounting. Our updated 2012 guidance includes the impact of these items, as well as transaction-related expenses, which continue to be forecast at approximately $1 million. Based on the timing of the acquisition, we expect the impact in the first quarter of 2012 to be immaterial and are therefore reiterating the guidance we gave on February 16, 2012, as follows: for the first quarter, revenue is expected to be in the range of $32.5 million to $34 million; non-GAAP net adjusted EBITDA in the range of $13.5 million to $14.5 million; GAAP earnings per diluted share in the range of $0.15 to $0.17; and non-GAAP earnings per diluted share in the range of $0.21 to $0.23. For the remaining 3 quarters of 2012, we expect additional revenue of $13 million to $14 million and incremental net adjusted EBITDA of $2 million to $3 million. GAAP EPS is expected to be neutral, and non-GAAP EPS is expected to be accretive by $0.03.

With that said, we've updated our 2012 annual guidance to include Bitstream. We now expect revenue of $146 million to $151 million or growth of 19% to 23%. We expect gross margins between 84% to 85% and operating expenses in the range of $80 million to $82 million. We expect net adjusted EBITDA in the range of $59 million to $63 million and non-GAAP diluted EPS in the range of $0.96 to $1.01.

Looking ahead, as we move past the impact of year 1 costs and adjustments, we expect the acquisition to generate approximately 30% net adjusted EBITDA margins. We are excited to have Bitstream as part of the Monotype family. We believe the acquisition will be another growth factor to support our long-term business goals of delivering double-digit organic revenue growth and net adjusted EBITDA margins of 40-plus percent.

With that, I would like to turn the call over to the operator for the question-and-answer session. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Ross MacMillan from Jefferies.

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

Scott, maybe you could just help us with a couple of things that you're making adjustments for. Could you help us at all with the magnitude of the write-down of deferred revenue this year?

Scott Landers

Sure. Actually, the deferred revenue component isn't that large. It's only a few hundred thousand dollars. The bigger issue will be around aligning the revenue recognition policies. As you know, we share similar businesses with Bitstream, and you can follow accounting practices that can be consistent -- or that can be different so long as that you're consistent. So as you know, Ross, the revenue stream at Monotype it typically spread over time, so certain OEM deals which may have been taken upfront in the past would be deferred and taken ratably over a period. In addition, there's potential on the website for certain things that are currently taken upfront to be spread perhaps over a one-year term. In total, it could be a couple million dollars.

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

Okay, that's helpful. And then also just along the same lines, some of the additional costs beyond the transaction expenses that you laid out already, what sort of magnitude of current integration and other costs are you looking at?

Scott Landers

Yes, I mean we're looking at potentially $0.5 million in the first year.

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

Okay, that's really helpful. And then just on linearity, once you've got that aligned to your rev rec policy, should the linearity -- obviously, 80% of the revenue here are on Creative Pro, be quite similar to your own Creative Pro business?

Scott Landers

Yes, it absolutely should be. Yes, I mean, you have some -- a little bit of seasonality on the CP side around the holiday season. But otherwise, it should be a fairly consistent spread throughout the year.

Douglas J. Shaw

What's a little different, Ross, about their Creative Professional business versus ours is Bitstream's is 100% off the Web. And as you know, on our Creative Professional side, it's half through our sales force and half through the Web. And particularly, the half through the sales force can be lumpy. We can get $0.25 million deal on one quarter or a couple of them; the next quarter, a little slower. So I'd say, honestly, their business is more predicable because it's 100% work the Web on the CP site.

Operator

Our next question comes from Barbara Coffey from Brigantine Advisors.

Barbara Coffey - Brigantine Advisors

Is the DOJ's review over, which meant you could proceed? And then my second question is when you purchased all these fonts, is there overlap, is there certain things that are duplicative in the kind of library? And then thirdly, will you be able to make those fonts available also on your Web services and your Web font services offering?

Scott Landers

So Barbie, it's Scott. First off on the DOJ, they have concluded their investigation which is -- would allow us here to proceed. And then I'll let Doug touch on the font side.

Douglas J. Shaw

On the font side, there is some duplication between the 2 libraries, but not as much as you would think, frankly. For example, on their side, they don't distribute any of our font. So one thing we'll do immediately is we'll take the Helvetica, the future, all of our classic typefaces, and then get them on MyFonts. And we own those, so those are really nice margin kind of products for us. Likewise, they have a lot of cutting-edge designs from hot designers around the world, and so we'll definitely leverage those across other e-commerce sites we have. So we've got some work to do as far as trying to figure out what's the personality of each one of our websites, but there'll definitely be cross-fertilization of these typeface libraries across our different properties.

Operator

[Operator Instructions] Our next question comes from Steven Frankel from Dougherty.

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

Is there any material difference in the conversion rates at MyFonts.com and your own web operation?

Douglas J. Shaw

Ah, I don't know the answer to that question. What's been a little interesting about this process is as we know Bitstream hired some bankers to look for alternatives, and so we learned an awful lot about the company during the bidding process. And really, up until about November -- now the DOJ, they have -- frankly, the communications were off a little bit because we had to be careful. So we'll get a little more catching up to do. I know that there were things where Bitstream talks a lot about high conversion rates, so my expectations is that it will be no worse than ours. Or, to put it another way, it's as good as ours and maybe better, but I frankly don't know. We'll dig into that.

Scott Landers

Yes, I would just add a little bit to that. The one thing we do know is they drive pretty much all natural traffic. So they're not paying to drive traffic to their sites, which is a skill set that will now be brought to Monotype, where as you know, Steve on the Monotype side, we have a much higher operating expense cost because we're spending a fair amount with Google to drive traffic. So my sense would be is since their traffic is coming maybe more naturally, that those conversion rates would be better.

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

Okay. And it maybe hard to know, but do you think the business lost a material amount of momentum due to this protracted sale process?

Douglas J. Shaw

Boy, not on the end user site. Their MyFonts site is at least doing what we hope it would do before the DOJ got involved. And the OEM business, it is loaded. It's a smaller business. It's only about 20% of their revenue, and it's a nice add-on, but it wasn't the reason why we -- it wasn't the primary reason why we had interest. MyFonts is doing quite well.

Operator

Our next question comes from Saket Kalia from JPMorgan.

Saket Kalia - JP Morgan Chase & Co, Research Division

So first, can you -- Scott, can you talk about any synergies down the road you think you can pursue? And are there any synergies assumed in the revised guidance?

Scott Landers

Well, we already have some synergies, the easy ones as far as leveraging G&A. I think the synergies as we look forward, a lot of them will be in the top line. So as Doug said before, currently, our IP is not being sold on MyFonts site, so that's a nice opportunity for us. Another big one coming back the other way is leveraging now the R&D center that we have in India. So as you know, Saket, organically within Monotype, there's a lot of new initiatives going on, and now having that resource pool to draw from and build on over time should be a pretty efficient way for us to go after some new opportunities.

Douglas J. Shaw

Yes. Another area of synergy is they really have a very small -- or had a very small sales force. They had nobody on the end user site, and they had 3 salespeople on their OEM business. So obviously we'll take their IP and put it right through our -- I don't know how many salespeople we have at Creative Professional, but 25, 30 people and then our whole OEM sales force as well. So I'd say we haven't built any big lift for that, so we think that's an upside. Basically, we'd looked at what their trends were and looked at our cost structure and said, "Hey, this is how it flows to this year and next." So I'd say the future, just like Scott said, really is -- can we grow their business at a faster rate than they grew it.

Saket Kalia - JP Morgan Chase & Co, Research Division

Right. Okay. And on this year's EBITDA contribution, the $2 million to $3 million, even if I add back about $0.5 million in integration cost, the profitability on the Bitstream asset seems lower than the 30%. So is that just kind of the revenue recognition realignment that's impacting it this year, and then let's it normalize next year?

Scott Landers

It absolutely is. So whenever you convert from a rev rec perspective, you always take a hit in the first year. And then after that, it would be comparable going forward. So, yes.

Saket Kalia - JP Morgan Chase & Co, Research Division

Okay. And then lastly, can you remind us the cost, remind us what you're paying on your revolver?

Scott Landers

It's LIBOR plus 225.

Operator

Our last question comes from Matthew Kempler from Sidoti.

Matthew J. Kempler - Sidoti & Company, LLC

Can you talk about the outreach efforts that you are going to make with the key font library contributors and developers to ensure continuity of the content on MyFonts.com?

Douglas J. Shaw

Oh, good question. So it's already started. Matter of fact, it started way back in November. So John Collins, who we mentioned, he's really the mastermind behind MyFonts years and years ago. He's also the one responsible for the -- his team, for the third-party relationships with the font foundries. So way back in November, we told the world we're interested in combining. John and his team proactively contacted, I think, all of the third-party foundries and talked to -- at least via e-mail, and talked to a lot of them one on one. And just basically, things are going well, the business is growing, you're getting nice royalty payments from us, and the plan is to keep that going. So to my knowledge, we had 0 dropoff, and we just think people see that -- or hope people see that we're a bigger, healthier company from a financial standpoint, and our plan is to put more resources behind it, so to grow the business at a faster rate. So 0 dropoff that I've heard of.

Matthew J. Kempler - Sidoti & Company, LLC

Okay. And then secondarily on the technology front, when you look at Bitstream's font rendering, layout, and Web font capabilities, is there anything specific that you find that might be additive to your offering?

Douglas J. Shaw

Yes, they do the same kind of things. So our product's called iType, and their's is called Font Fusion. And we have a WorldType Layout Manager, they call it Panorama. We think there might be some specific environments, very, very memory-constrained environments that their technology might be better for certain chipsets. So we actually had last week about 1/2 dozen people from the Indian operation in the office and go into with more detail what their products do from a technical standpoint. So I'd say we're still in the fact finding. Ultimately, we'll want to make this -- to simplify this to our customers. And the nice part of our software is we can pull pieces out of different components and put it all under one banner. So I think we're going to get some nice kernels, but we won't -- long term, I don't think offer redundant solutions. We'll pick one that makes sense.

Operator

There appears to be no further questions at this time. Please continue with any points you wish to raise.

Douglas J. Shaw

Okay. Well, in closing, I'd like to reiterate that as Bitstream provides us with new prospects to grow our customer base, expand our IP and capture emerging growth opportunities, particularly in Web font services and our Display Imaging business. We believe that our global reach and financial strength, combined with Bitstream's font 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. Thank you for joining us, and we look forward to speaking with you soon. Take care.

Operator

Thank you. This does conclude your conference call for today. Thank you for your participation. You may now disconnect.

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