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Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2011

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from             to             

Commission File Number 001-33612

 

 

MONOTYPE IMAGING HOLDINGS INC.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   20-3289482
(State of incorporation)   (I.R.S. Employer Identification No.)

500 Unicorn Park Drive

Woburn, Massachusetts

  01801
(Address of principal executive offices)   (Zip Code)

Registrant’s telephone number, including area code: (781) 970-6000

(Former Name, Former Address and Former Fiscal year, if changed since last report)

 

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   ¨    Accelerated filer   x
Non-accelerated filer   ¨    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

The number of shares outstanding of the registrant’s common stock as of July 27, 2011 was 36,032,535.

 

 

 


Table of Contents

MONOTYPE IMAGING HOLDINGS INC.

INDEX

 

          Page  

Part I. Financial Information

     2   

Item 1. 

   Consolidated Financial Statements (Unaudited)      2   
  

•      Condensed Consolidated Balance Sheets as of  June 30, 2011 and December 31, 2010

     2   
  

•       Condensed Consolidated Statements of Income for the three and six months ended June 30, 2011 and 2010

     3   
  

•       Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2011 and 2010

     4   
  

•      Notes to Condensed Consolidated Financial Statements

     5   

Item 2

   Management’s Discussion and Analysis of Financial Condition and Results of Operations      13   

Item 3. 

   Quantitative and Qualitative Disclosures About Market Risk      24   

Item 4. 

   Controls and Procedures      25   

Part II. Other Information

     26   

Item 1. 

   Legal Proceedings      26   

Item 1A.

   Risk Factors      26   

Item 2. 

   Unregistered Sales of Equity Securities and Use of Proceeds      26   

Item 3. 

   Defaults Upon Senior Securities      27   

Item 4. 

   Removed and Reserved      27   

Item 5. 

   Other Information      27   

Item 6. 

   Exhibits      27   

Signatures

     28   

Exhibit Index

     29   

 

1


Table of Contents

PART I. FINANCIAL INFORMATION

 

Item 1. Condensed Consolidated Financial Statements

MONOTYPE IMAGING HOLDINGS INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited and in thousands, except share and per share data)

 

     June 30,
2011
    December 31,
2010
 
Assets     

Current assets:

    

Cash and cash equivalents

   $ 53,060      $ 42,786   

Accounts receivable, net of allowance for doubtful accounts of $120 at June 30, 2011 and $92 at December 31, 2010

     6,080        4,720   

Income tax refunds receivable

     440        340   

Deferred income taxes

     436        350   

Prepaid expenses and other current assets

     2,297        2,480   
  

 

 

   

 

 

 

Total current assets

     62,313        50,676   

Property and equipment, net

     1,925        1,589   

Goodwill

     145,843        142,354   

Intangible assets, net

     77,021        80,239   

Other assets

     4,175        3,947   
  

 

 

   

 

 

 

Total assets

   $ 291,277      $ 278,805   
  

 

 

   

 

 

 
Liabilities and Stockholders’ Equity     

Current liabilities:

    

Accounts payable

   $ 513      $ 753   

Accrued expenses and other current liabilities

     9,842        13,045   

Accrued income taxes

     —          1,171   

Deferred revenue

     11,300        8,506   

Current portion of long-term debt

     10,000        8,355   
  

 

 

   

 

 

 

Total current liabilities

     31,655        31,830   

Long-term debt, less current portion

     47,344        57,504   

Other long-term liabilities

     765        471   

Deferred income taxes

     22,372        19,328   

Reserve for income taxes, net of current portion

     1,238        1,125   

Accrued pension benefits

     3,993        3,565   

Commitments and contingencies (Note 15)

    

Stockholders’ equity:

    

Preferred stock, $0.001 par value, Authorized shares: 10,000,000; Issued and outstanding: none

     —          —     

Common stock, $0.001 par value, Authorized shares: 250,000,000; Issued: 36,014,427 at June 30, 2011 and 35,490,331 at December 31, 2010

     36        35   

Additional paid-in capital

     161,489        155,791   

Treasury stock, at cost, 98,183 shares at June 30, 2011 and 95,516 shares at December 31, 2010

     (86     (86

Retained earnings

     19,355        8,317   

Accumulated other comprehensive income

     3,116        925   
  

 

 

   

 

 

 

Total stockholders’ equity

     183,910        164,982   
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 291,277      $ 278,805   
  

 

 

   

 

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

2


Table of Contents

MONOTYPE IMAGING HOLDINGS INC.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(Unaudited and in thousands, except share and per share data)

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2011     2010     2011     2010  

Revenue

   $ 31,066      $ 24,435      $ 60,795      $ 48,896   

Costs and expenses:

        

Cost of revenue

     2,961        1,910        4,987        3,728   

Cost of revenue—amortization of acquired technology

     798        868        1,575        1,739   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total cost of revenue

     3,759        2,778        6,562        5,467   
  

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     27,307        21,657        54,233        43,429   

Operating expenses:

        

Marketing and selling

     8,231        6,204        16,029        12,178   

Research and development

     3,933        3,570        8,060        7,591   

General and administrative

     4,144        4,072        8,337        8,096   

Amortization of other intangible assets

     1,304        1,187        2,595        2,388   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     17,612        15,033        35,021        30,253   

Income from operations

     9,695        6,624        19,212        13,176   

Other (income) expense:

        

Interest expense

     885        1,108        1,801        2,303   

Interest income

     (25     —          (62     (13

(Gain) loss on foreign exchange

     (85     1,701        (481     2,689   

Loss (gain) on derivatives

     351        (1,008     1,023        (1,765

Other (income) expense, net

     —          (9     —          (9
  

 

 

   

 

 

   

 

 

   

 

 

 

Total other expense

     1,126        1,792        2,281        3,205   

Income before provision for income taxes

     8,569        4,832        16,931        9,971   

Provision for income taxes

     2,971        1,788        5,893        3,665   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 5,598      $ 3,044      $ 11,038      $ 6,306   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income available to common stockholders – basic & diluted

   $ 5,502      $ 3,022      $ 10,861      $ 6,266   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income per common share:

        

Basic

   $ 0.16      $ 0.09      $ 0.31      $ 0.18   

Diluted

   $ 0.15      $ 0.08      $ 0.30      $ 0.17   

Weighted average number of shares:

        

Basic

     35,308,941        34,727,219        35,176,156        34,651,885   

Diluted

     36,772,515        35,992,541        36,638,697        35,924,077   

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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MONOTYPE IMAGING HOLDINGS INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited and in thousands)

 

     Six Months Ended
June 30,
 
     2011     2010  

Cash flows from operating activities

    

Net income

   $ 11,038      $ 6,306   

Adjustments to reconcile net income to net cash provided by operating activities:

    

Depreciation and amortization

     4,667        4,648   

Loss on retirement of fixed assets

     —          3   

Amortization of deferred financing costs

     340        423   

Share based compensation

     3,322        2,811   

Excess tax benefit on stock options

     (898     (395

Provision for doubtful accounts

     71        16   

Deferred income taxes

     559        526   

Unrealized currency (gain) loss on foreign denominated intercompany transactions

     (451     2,140   

Unrealized loss (gain) on derivatives

     885        (1,820

Changes in operating assets and liabilities:

    

Accounts receivable

     (1,217     627   

Income tax refunds receivable

     (100     —     

Prepaid expenses and other assets

     (113     590   

Accounts payable

     (253     562   

Accrued income taxes

     (1,161     147   

Accrued expenses and other liabilities

     (2,303     943   

Deferred revenue

     3,083        4,391   
  

 

 

   

 

 

 

Net cash provided by operating activities

     17,469        21,918   
  

 

 

   

 

 

 

Cash flows from investing activities

    

Purchases of property and equipment

     (791     (189

Purchase of exclusive license

     —          (2,000
  

 

 

   

 

 

 

Net cash used in investing activities

     (791     (2,189
  

 

 

   

 

 

 

Cash flows from financing activities

    

Payments on long-term debt

     (8,855     (10,583

Excess tax benefit on stock options

     898        395   

Proceeds from exercises of common stock options

     1,480        476   
  

 

 

   

 

 

 

Net cash used in financing activities

     (6,477     (9,712

Effect of exchange rates on cash and cash equivalents

     73        39   
  

 

 

   

 

 

 

Increase in cash and cash equivalents

     10,274        10,056   

Cash and cash equivalents at beginning of period

     42,786        34,616   
  

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 53,060      $ 44,672   
  

 

 

   

 

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

4


Table of Contents

MONOTYPE IMAGING HOLDINGS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2011

1. Nature of the Business

Monotype Imaging Holdings Inc. (the “Company” or “we”) is a leading global provider of text imaging solutions. Our end-user and embedded solutions for print, web and mobile environments enable people to create and consume dynamic content on any and every device. The Company’s technologies and fonts enable the display and printing of high quality digital content. The Company’s software technologies have been widely deployed across, and embedded in, a range of consumer electronics, or CE devices, including laser printers, digital copiers, mobile phones, navigation devices, digital cameras, e-book readers, digital televisions, set-top boxes and consumer appliances, as well as in numerous software applications and operating systems. We license our text imaging solutions to CE device manufacturers, independent software vendors and creative and business professionals and we are headquartered in Woburn, Massachusetts. We operate in one business segment: the development, marketing and licensing of technologies and fonts. The Company also maintains various offices worldwide for selling and marketing, research and development and administration. We conduct our operations through two domestic operating subsidiaries, Monotype Imaging Inc. and International Typeface Corporation, and four foreign operating subsidiaries, Monotype Imaging Ltd., Linotype GmbH (“Linotype”), Monotype Imaging Hong Kong Ltd. and Monotype Imaging KK.

2. Basis of Presentation

The accompanying unaudited condensed consolidated interim financial statements as of June 30, 2011 and for the three and six months ended June 30, 2011 and 2010 include the accounts of the Company and its wholly-owned subsidiaries and have been prepared in conformity with accounting principles generally accepted in the United States (“GAAP”) for interim financial reporting and pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) for Quarterly Reports on Form 10-Q and Article 10 of Regulation S-X. Accordingly, such financial statements do not include all of the information and footnotes required by GAAP for complete financial statements. GAAP requires the Company’s management to make estimates and assumptions that affect the amounts reported in the financial statements. Actual results could differ from those estimates. The results for interim periods are not necessarily indicative of results to be expected for the year or for any future periods.

In management’s opinion, these unaudited condensed consolidated interim financial statements contain all adjustments of a normal recurring nature necessary for a fair presentation of the financial statements for the interim periods presented.

These unaudited condensed consolidated interim financial statements should be read in conjunction with the Company’s audited consolidated financial statements for the year ended December 31, 2010 as reported in the Company’s Annual Report on Form 10-K.

3. Recently Issued Accounting Pronouncements

Comprehensive Income

In June 2011, the Financial Accounting Standards Board (“FASB”) issued ASC Topic No. 220, Comprehensive Income, which amended its guidance on the presentation of comprehensive income in financial statements to improve the comparability, consistency and transparency of financial reporting and to increase the prominence of items that are recorded in other comprehensive income. The new accounting guidance requires entities to report components of comprehensive income in either (1) a single statement of comprehensive income immediately following the income statement or (2) a separate statement of comprehensive income immediately following the income statement. Companies will no longer be allowed to present comprehensive income on the statement of changes in shareholders’ equity. In both options, companies must present the components of net income, total net income, the components of other comprehensive income, total other comprehensive income and total comprehensive income. The provisions of this new guidance are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011 and will require retrospective application for all periods presented. We are currently evaluating the impact of adopting this guidance on our financial statements.

Fair Value Measurements and Disclosures

In January 2010, the FASB issued ASC Topic No. 820, Fair Value Measurements and Disclosures, (“ASC 820”). ASC 820 improves disclosures about fair value measurements, requiring disclosures about valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements (class Level 2 or Level 3). Details regarding each class level, as defined by ASC 820, can be found in Note 5. In addition, more details are required regarding significant transfers between Levels 1 and 2 and the reasons for these transfers. New disclosures and clarifications regarding existing disclosures are effective for interim and annual reporting periods beginning after December 15, 2009, except for details regarding purchases, sales, issuances and settlements in the activity roll forward of class Level 3 which is effective for fiscal periods beginning after December 15, 2010 and interim periods within those fiscal periods. We adopted the first provision of ASC 820 and the adoption did not have a material impact on the

 

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Company’s results of operations, financial position or liquidity. The Company adopted the second provision of ASC 820 on January 1, 2011 and the adoption did not have a material impact on its results of operations, financial position or liquidity.

Multiple-Deliverable Revenue Arrangements

In October 2009, the FASB approved for issuance ASC Subtopic No. 605-25, Revenue Recognition Multiple-Element Arrangements, (“ASC 605-25”). ASC 605-25 provides principles for allocation of consideration among its multiple-elements, allowing more flexibility in identifying and accounting for separate deliverables under an arrangement. It introduces an estimated selling price method for valuing the elements of a bundled arrangement if vendor-specific objective evidence or third-party evidence of selling price is not available, and significantly expands related disclosure requirements. ASC 605-25 is effective on a prospective basis for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. Alternatively, adoption may be on a retrospective basis, and early application is permitted. The Company adopted ASC 605-25 on January 1, 2011 and the adoption did not have an impact on its results of operations, financial position or liquidity for all periods presented.

4. Acquisition

On December 8, 2010, we acquired Ascender Corporation, a privately held Illinois corporation, and Font Commerce LLC, a majority owned subsidiary of Ascender (together, “Ascender”) for approximately $11.0 million, subject to final adjustments. Ascender is a font provider with long-standing relationships with several leading brands including Google and Microsoft, and is located in Elk Grove Village, Illinois. With the acquisition of Ascender, the Company has broadened its font intellectual property offerings and gained significant typeface design and development talent. The Company paid approximately $7.2 million in cash, $0.2 million was accrued, pending final adjustments, and issued 285,632 shares of common stock, valued at $3.2 million. The purchase accounting is preliminary and subject to adjustment for final settlement related to acquired assets and liabilities. There were no significant changes to the initial purchase accounting during the quarter ended June 30, 2011.

5. Derivative Financial Instruments

On May 24, 2010, we entered into a long term interest rate swap contract to pay a fixed rate of interest of 1.5% in exchange for a floating rate interest payment tied to the one-month London Inter-Bank Offering Rate (“LIBOR”) beginning January 2011 to mitigate our exposure to interest rate fluctuations on our debt obligations for the remainder of the term of the note. The contract has a notional amount of $50.0 million with a $20.0 million reduction in the notional amount in 2012 and matures on July 30, 2012. The total fair value of this financial instrument at June 30, 2011 and December 31, 2010 was a liability of $0.5 million and $0.7 million, respectively. We did not designate the contract as a hedge; as such, associated gains and losses are recorded in loss (gain) on derivatives in our condensed consolidated statements of income. The current portion of the interest rate swap is included in accrued expenses and other current liabilities and the long-term portion of the swap is included in other long-term liabilities in the accompanying condensed consolidated balance sheets.

On May 7, 2008, we entered into a long term currency swap contract to purchase 18.3 million Euros in exchange for $28.0 million to mitigate foreign currency exchange rate risk on a Euro denominated intercompany note. We incurred a net gain of $0.2 million and a net loss of $1.4 million on the intercompany note for the three months ended June 30, 2011 and 2010, respectively. In the six months ended June 30, 2011 and 2010, we incurred a net gain of $0.8 million and a net loss of $2.4 million, respectively, on the intercompany note, which is included in (gain) loss on foreign exchange in the accompanying condensed consolidated statements of income. The currency swap matures on December 14, 2012. The contract payment terms approximate the payment terms of this intercompany note. The currency swap contract reduces the availability under our revolving line-of-credit by $4.0 million. The total fair value of the financial instrument at June 30, 2011 and December 31, 2010 was an asset of approximately $0.5 million and $1.5 million, respectively. The current portion of the currency swap is included in prepaid expenses and other current assets and the long-term portion of the swap is included in other assets in our accompanying condensed consolidated balance sheets.

The following table presents the losses and (gains) on our derivative financial instruments which are included in loss (gain) on derivatives in our accompanying condensed consolidated statements of income (in thousands):

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2011      2010     2011      2010  

Interest rate swaps

   $ 94       $ 384      $ 140       $ 485   

Currency swap

     257         (1,392     883         (2,253

Other

     —           —          —           3   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 351       $ (1,008   $ 1,023       $ (1,765
  

 

 

    

 

 

   

 

 

    

 

 

 

We also incur foreign currency exchange gains and losses related to certain customers that are invoiced in U.S. dollars, but who have the option to make an equivalent payment in their own functional currencies at a specified exchange rate as of a specified date. In

 

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the period from that date until payment in the customer’s functional currency is received and converted into U.S. dollars, we can incur unrealized gains and losses. We utilize forward contracts with maturities of 90 days or less to hedge our exposure to these currency fluctuations. Any increase or decrease in the fair value of the forward contracts is offset by the change in the value of the hedged assets of our consolidated foreign affiliate. There were no outstanding currency hedges at June 30, 2011 or December 31, 2010.

6. Fair Value Measurements

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. In order to increase consistency and comparability in fair value measurements, the Financial Accounting Standards Codification established a fair value hierarchy that prioritizes observable and unobservable inputs used to measure fair value into three broad levels, which are described below:

Level 1: Quoted prices (unadjusted) in active markets that are accessible at the measurement date for assets or liabilities. The fair value hierarchy gives the highest priority to Level 1 inputs.

Level 2: Other inputs that are observable directly or indirectly, such as quoted prices for similar assets and liabilities or market corroborated inputs.

Level 3: Unobservable inputs are used when little or no market data is available and requires the company to develop its own assumptions about how market participants would price the assets or liabilities. The fair value hierarchy gives the lowest priority to Level 3 inputs.

In determining fair value, the Company utilizes valuation techniques that maximize the use of observable inputs and minimizes the use of unobservable inputs to the extent possible as well as considers counterparty and our own credit risk in its assessment of fair value.

The following table presents our financial assets and liabilities that are carried at fair value, classified according to the three categories described above (in thousands):

 

     Fair Value Measurement at June 30, 2011  
     Total      Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
     Significant Other
Observable Inputs
(Level 2)
     Significant
Unobservable
Inputs
(Level 3)
 

Assets:

           

Cash equivalents—money market funds

   $ 4,554       $ 4,554      $ —         $ —     

Cash equivalents—commercial paper

     2,149         —           2,149         —     

Cash equivalents—corporate bonds

     3,013         —           3,013         —     

Cash equivalents—municipal bonds

     10,255         —           10,255         —     

Derivatives – currency swap, current portion

     275         —           275         —     

Derivatives – currency swap, long-term portion

     197         —           197         —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total assets

   $ 20,443       $ 4,554      $ 15,889       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Liabilities:

           

Derivatives – interest rate swap, current portion

   $ 494       $ —         $ 494       $ —     

Derivatives – interest rate swap, long-term portion

     46         —           46         —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total liabilities

   $ 540       $ —         $ 540       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 

The Company’s recurring fair value measures relate to short-term investments, which are classified as cash equivalents and derivative instruments. The fair value of our cash equivalents are either based on quoted prices for similar assets or other observable inputs such as yield curves at commonly quoted intervals and other market corroborated inputs. The fair value of our derivatives is based on quoted market prices of similar instruments from various banking institutions or an independent third party provider for similar instruments. In determining the fair value, we consider our non-performance risk and that of our counterparties. At June 30, 2011 the fair value of our long-term debt approximated its carrying value of $58.0 million. The Company’s non-financial assets and non-financial liabilities subject to non-recurring measures include goodwill and intangible assets.

 

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7. Intangible Assets

Intangible assets consist of the following (dollar amounts in thousands):

 

            June 30, 2011      December 31, 2010  
      Life (Years)      Gross
Carrying
Amount
     Accumulated
Amortization
    Net
Balance
     Gross
Carrying
Amount
     Accumulated
Amortization
    Net
Balance
 

Customer relationships

     7-15       $ 49,911       $ (28,943   $ 20,968       $ 49,419       $ (26,413   $ 23,006   

Acquired technology

     8-15         40,000         (19,531     20,469         39,846         (17,878     21,968   

Non-compete agreements

     3-6         12,150         (11,661     489         12,039         (11,363     676   

Trademarks

        30,695         —          30,695         30,189         —          30,189   

Domain names

        4,400         —          4,400         4,400         —          4,400   
     

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Total

      $ 137,156       $ (60,135   $ 77,021       $ 135,893       $ (55,654   $ 80,239   
     

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

8. Debt

Long-term debt consists of the following (in thousands):

 

     June 30, 2011     December 31, 2010  

Credit Facility—$57.5 million, interest at London Inter-Bank Offering Rate (LIBOR) plus 3.75% (3.94% at June 30, 2011), and $0.5 million at Prime plus 2.25% (5.50% at June 30, 2011) due in monthly installments of principal and interest through July 2012

   $ 57,990      $ 66,845   

Less unamortized financing costs

     (646     (986
  

 

 

   

 

 

 

Total debt

     57,344        65,859   

Less current portion

     (10,000     (8,355
  

 

 

   

 

 

 

Long-term debt

   $ 47,344      $ 57,504   
  

 

 

   

 

 

 

We were subject to a maximum leverage ratio and a minimum liquidity requirement under the terms of our credit facility arranged by Wells Fargo Foothill, or our Amended and Restated Credit Agreement, and we were in compliance with the covenants under our Amended and Restated Credit Agreement as of June 30, 2011.

On July 13, 2011 we entered into a $120.0 million revolving credit facility (the “Credit Facility”) with our lender and terminated our Amended and Restated Credit Agreement. For further details see our subsequent events footnote, Note 16. In accordance with ASC Subtopic No. 210-10-45, Balance Sheet, Other Presentation Matters, the Company has classified $10.0 million in the current portion of long-term debt within the consolidated balance sheet at June 30, 2011 for payments reasonably expected to be made on the revolving credit facility during the next twelve months.

9. Defined Benefit Pension Plan

Linotype maintains an unfunded defined benefit pension plan based on the “Versorgungsordnung der Heidelberger Druckmaschinen AG” (the “Linotype Plan”) which covers substantially all employees of Linotype who joined before April 1, 2006, at which time the Linotype Plan was closed. Employees are entitled to benefits in the form of retirement, disability and surviving dependent pensions. Benefits generally depend on years of service and the salary of the employees.

The components of net periodic benefit cost included in the accompanying condensed consolidated statements of income were as follows (in thousands):

 

     Three Months Ended
June 30,
     Six Months Ended
June 30,
 
     2011      2010      2011      2010  

Service cost

   $ 22       $ 19       $ 43       $ 40   

Interest cost

     47         40         93         83   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net periodic benefit cost

   $ 69       $ 59       $ 136       $ 123   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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10. Income Taxes

A reconciliation of income taxes computed at federal statutory rates to income tax expense is as follows (dollar amounts in thousands):

 

     Three Months Ended June 30,  
     2011     2010  

Provision for income taxes at statutory rate

   $ 2,999        35.0   $ 1,692        35.0

State and local income taxes, net of federal tax benefit

     106        1.2     90        1.9

Stock compensation

     65        0.8     51        1.0

Research credits

     (73     (0.9 )%      —          —     

Disqualifying dispositions on incentive stock options

     (58     (0.7 )%      (26     (0.5 )% 

Other, net

     (68     (0.7 )%      (19     (0.4 )% 
  

 

 

   

 

 

   

 

 

   

 

 

 

Reported income tax provision

   $ 2,971        34.7   $ 1,788        37.0
  

 

 

   

 

 

   

 

 

   

 

 

 

 

     Six Months Ended June 30,  
     2011     2010  

Provision for income taxes at statutory rate

   $ 5,926        35.0   $ 3,490        35.0

State and local income taxes, net of federal tax benefit

     208        1.2     186        1.9

Stock compensation

     128        0.8     106        1.1

Research credits

     (143     (0.9 )%      —          —     

Disqualifying dispositions on incentive stock options

     (94     (0.5 )%      (70     (0.7 )% 

Other, net

     (132     (0.8 )%      (47     (0.5 )% 
  

 

 

   

 

 

   

 

 

   

 

 

 

Reported income tax provision

   $ 5,893        34.8   $ 3,665        36.8
  

 

 

   

 

 

   

 

 

   

 

 

 

At both June 30, 2011 and December 31, 2010, the reserve for uncertain tax positions (including related interest) was approximately $1.2 million.

11. Comprehensive Income

The components of comprehensive income are as follows (in thousands):

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2011      2010     2011      2010  

Net income

   $ 5,598       $ 3,044      $ 11,038       $ 6,306   

Net changes in:

          

Foreign currency translation adjustment, net of tax of $389, ($1,223), $1,245 and ($412), respectively

     681         (2,104     2,191         (3,503
  

 

 

    

 

 

   

 

 

    

 

 

 

Total comprehensive income

   $ 6,279       $ 940      $ 13,229       $ 2,803   
  

 

 

    

 

 

   

 

 

    

 

 

 

12. Net Income Per Share

Basic and diluted earnings per share are computed pursuant to the two-class method. The two-class method determines earnings per share for each class of common stock and participating security according to their respective participation rights in undistributed earnings. Unvested restricted stock awards granted to employees are considered participating securities as they receive non-forfeitable rights to cash dividends at the same rate as common stock. In accordance with ASC Topic No. 260, diluted net income per share is calculated using the more dilutive of the following two approaches:

 

  1. Assume exercise of stock options and vesting of restricted stock using the treasury stock method.

 

  2. Assume exercise of stock options using the treasury stock method, but assume participating securities (unvested restricted stock) are not vested and allocate earnings to common shares and participating securities using the two-class method.

 

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For all periods presented, the treasury stock method was used in the computation of diluted net income per share, as the result was more dilutive. The following presents a reconciliation of the numerator and denominator used in the calculation of basic and diluted net income per share (in thousands, except share and per share data):

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2011     2010     2011     2010  

Numerator:

        

Net income, as reported

   $ 5,598      $ 3,044      $ 11,038      $ 6,306   

Less: net income attributable to participating securities

     (96     (22     (177     (40
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income available to common shareholders—basic and diluted

   $ 5,502      $ 3,022      $ 10,861      $ 6,266   
  

 

 

   

 

 

   

 

 

   

 

 

 

Denominator:

        

Basic:

        

Weighted-average shares of common stock outstanding

     35,921, 920        34,980,893        35,749,722        34,872,740   

Less: weighted-average shares of unvested restricted common stock outstanding

     (612,979     (253,674     (573,566     (220,855
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted-average number of common shares used in computing basic net income per common share

     35,308,941        34,727,219        35,176,156        34,651,885   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income per share applicable to common shareholders—basic

   $ 0.16      $ 0.09      $ 0.31      $ 0.18   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted:

        

Weighted-average shares of common stock outstanding

     35,921,920        34,980,893        35,749,722        34,872,740   

Less: weighted-average shares of unvested restricted common stock outstanding

     (612,979     (253,674     (573,566     (220,855

Weighted-average number of common shares issuable upon exercise of outstanding stock options, based on the treasury stock method

     1,330,626        1,207,718        1,345,784        1,203,576   

Weighted-average number of restricted stock, based on the treasury stock method

     132,948        57,604        116,757        68,616   
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted-average number of common shares used in computing diluted net income per common share

     36,772,515        35,992,541        36,638,697        35,924,077   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income per share applicable to common shareholders—diluted

   $ 0.15      $ 0.08      $ 0.30      $ 0.17   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

 

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The following common share equivalents have been excluded from the computation of diluted weighted-average shares outstanding, as their effect would have been anti-dilutive:

 

     Three Months Ended
June 30,
     Six Months Ended
June 30,
 
     2011      2010      2011      2010  

Options

     1,616,438         1,705,204         1,347,115         1,433,447   

The Company excludes options with combined exercise prices, and unvested restricted stock with unamortized fair values that are greater than the average market price for the Company’s common stock from the calculation of diluted net income per share because their effect is anti-dilutive.

13. Share Based Compensation

We account for share based compensation in accordance with ASC Topic No. 718, Compensation – Stock Compensation, which requires the measurement of compensation costs at fair value on the date of grant and recognition of compensation expense over the service period for awards expected to vest. The following presents the impact of share based compensation expense on our condensed consolidated statements of income (in thousands):

 

     Three Months Ended
June 30,
     Six Months Ended
June 30,
 
     2011      2010      2011      2010  

Marketing and selling

   $ 728       $ 543       $ 1,395       $ 1,023   

Research and development

     409         309         773         615   

General and administrative

     616         622         1,154         1,173   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total share based compensation

   $ 1,753       $ 1,474       $ 3,322       $ 2,811   
  

 

 

    

 

 

    

 

 

    

 

 

 

As of June 30, 2011, the Company had $14.9 million of unrecognized compensation expense related to employees and directors unvested stock option awards and restricted stock awards that are expected to be recognized over a weighted average period of 3.0 years.

14. Segment Reporting

We view our operations and manage our business as one segment: the development, marketing and licensing of technologies and fonts. Factors used to identify our single segment include the financial information available for evaluation by our chief operating decision maker in making decisions about how to allocate resources and assess performance. While our technologies and services are sold into two principal markets, OEM and creative professional, expenses and assets are not formally allocated to these market segments, and operating results are assessed on an aggregate basis to make decisions about the allocation of resources. The following table presents revenue for these two major markets (in thousands):

 

     Three Months Ended
June 30,
     Six Months Ended
June 30,
 
     2011      2010      2011      2010  

OEM

   $ 22,885       $ 18,387       $ 44,783       $ 36,008   

Creative professional

     8,181         6,048         16,012         12,888   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 31,066       $ 24,435       $ 60,795       $ 48,896   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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Geographic segment information

The Company attributes revenues to geographic areas based on the location of our subsidiary receiving such revenue. For example, licenses may be sold to large international companies which may be headquartered in Korea, but the sales are received and recorded by our subsidiary located in the United States. In this example, the revenue would be reflected in the United States totals in the table below. We market our products and services through offices in the U.S., United Kingdom, Germany, Hong Kong, Korea and Japan. The following summarizes revenue by location:

 

     Three Months Ended
June 30,
 
     2011     2010  
     Sales      % of Total     Sales      % of Total  
     (In thousands, except percentages)  

United States

   $ 13,921         44.8   $ 8,904         36.4

Asia

     10,684         34.4        10,718         43.9   

United Kingdom

     1,683         5.4        1,154         4.7   

Germany

     4,778         15.4        3,659         15.0   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 31,066         100.0   $ 24,435         100.0
  

 

 

    

 

 

   

 

 

    

 

 

 

 

     Six Months Ended
June 30,
 
     2011     2010  
     Sales      % of Total     Sales      % of Total  
     (In thousands, except percentages)  

United States

   $ 27,211         44.7   $ 17,831         36.5

Asia

     21,503         35.4        21,105         43.2   

United Kingdom

     2,803         4.6        2,468         5.0   

Germany

     9,278         15.3        7,492         15.3   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 60,795         100.0   $ 48,896         100.0
  

 

 

    

 

 

   

 

 

    

 

 

 

Long-lived assets, which include property, plant and equipment, goodwill and intangible assets, but exclude other assets, long-term investments and deferred tax assets, are attributed to geographic areas in which Company assets reside and is shown below (in thousands):

 

     June 30,
2011
     December 31,
2010
 

Long-lived assets:

     

United States

   $ 160,813       $ 164,213   

Asia

     3,343         3,402   

United Kingdom

     64         31   

Germany

     60,569         56,536   
  

 

 

    

 

 

 

Total

   $ 224,789       $ 224,182   
  

 

 

    

 

 

 

15. Commitments and Contingencies

Legal Proceedings

From time to time, we may be a party to various claims, suits and complaints. We are not currently a party to any legal proceedings that, if determined adversely to us, would have a material adverse effect on our business, results of operations or financial condition.

Licensing Warranty

Under our standard license agreement with our OEM customers, we warrant that the licensed technologies are free of infringement claims of intellectual property rights and will meet the specifications as defined in the licensing agreement for a specified period, typically one year. Under the licensing agreements, liability for such indemnity obligations is limited generally to the total arrangement fee; however, exceptions have been made on a case-by-case basis, increasing the maximum potential liability to agreed upon amounts at the time the contract is entered into. We have never incurred costs payable to a customer or business partner to defend lawsuits or settle claims related to these warranties, and as a result, management believes the estimated fair value of these warranties is minimal. Accordingly, there are no liabilities recorded for these warranties as of June 30, 2011 and December 31, 2010.

 

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16. Subsequent Events

On July 13, 2011 the Company entered into a new credit agreement with Wells Fargo Capital Finance, LLC and terminated its Amended and Restated Credit Agreement, which was scheduled to expire on July 30, 2012. The agreement provides the Company with a five-year $120.0 million secured revolving credit facility.

Borrowings under the Credit Facility bear interest at a variable rate based upon, at the Company’s option, either LIBOR or the base rate (which is the highest of (i) the prime rate, (ii) 0.5% plus the overnight federal funds rate, and (iii) 1.0% in excess of the three-month LIBOR rate), plus in each case, an applicable margin. The applicable margin for LIBOR loans, based on the applicable leverage ratio, is either 2.25% or 2.50% per annum, and the applicable margin for base rate loans, based on the applicable leverage ratio, is either 1.25% or 1.50% per annum. The Company is required to pay a commitment fee equal to 0.375% per annum on the undrawn portion available under the revolving credit facility and variable per annum fees in respect of outstanding letters of credit, if any.

The Credit Facility contains financial covenants which include (i) a maximum ratio of consolidated total debt to consolidated adjusted EBITDA of 3.00:1.00 and (ii) a minimum consolidated fixed charge coverage ratio of 1.25:1.00. Adjusted EBITDA, under the Credit Facility, is defined as consolidated net earnings (or loss), plus net interest expense, income taxes, depreciation and amortization and share based compensation expense, plus acquisition expenses not to exceed $2.0 million, plus restructuring, issuance costs, cash non-operating costs and other expenses or losses minus cash non-operating gains and other non-cash gains; provided however that the aggregate of all cash non-operating expense shall not exceed $250 thousand and all such fees, costs and expenses shall not exceed $1.5 million on a trailing twelve months basis. Failure to comply with these covenants, or the occurrence of an event of default, could permit the Lenders under the Credit Facility to declare all amounts borrowed under the Credit Facility, together with accrued interest and fees, to be immediately due and payable. In addition, the Credit Facility places limits on the Company and its subsidiaries ability to incur debt or liens and engage in sale-leaseback transactions, make loans and investments, incur additional indebtedness, engage in mergers, acquisitions and asset sales, transact with affiliates and alter its business.

In accordance with ASC Subtopic No. 210-10-45, Balance Sheet, Other Presentation Matters, the Company has classified $10.0 million in the current portion of long-term debt within the consolidated balance sheet at June 30, 2011, for payments reasonably expected to be made on the revolving credit facility during the next twelve months. In accordance with the agreement, there are no required scheduled repayments; payments and draws are made at the Company’s discretion during the life of the agreement.

In connection with the refinancing, the Company incurred closing fees of $0.8 million plus legal fees of approximately $0.4 million. In accordance with ASC Subtopic No. 470-50, Modifications and Extinguishments of Debt, these fees have been accounted for as deferred financing costs and will be amortized to interest expense over the term of the Credit Facility. In addition, approximately $0.4 million of unamortized deferred financing costs associated with the pro-rata share of prior loan syndicate lenders that did not participate in the new Credit Facility will be written off and charged to other expense in the third quarter of 2011.

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward Looking Statements and Projections

This Quarterly Report on Form 10-Q contains forward looking statements. Forward looking statements relate to future events or our future financial performance. We generally identify forward looking statements by terminology such as “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “could,” “intends,” “target,” “projects,” “contemplates,” “believes,” “estimates,” “predicts,” “potential” or “continue” or the negative of these terms or other similar words. These statements are only predictions. We have based these forward looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our business, results of operations and financial condition. The outcome of the events described in these forward looking statements is subject to risks, uncertainties and other factors described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Risk Factors” and elsewhere in this Quarterly Report on Form 10-Q. Accordingly, you should not rely upon forward looking statements as predictions of future events. We cannot assure you that the events and circumstances reflected in the forward looking statements will be achieved or occur, and actual results could differ materially from those projected in the forward looking statements. The forward looking statements made in this Quarterly Report on Form 10-Q relate only to events as of the date on which the statements are made. We undertake no obligation to update any forward looking statement to reflect events or circumstances after the date on which the statement is made or to reflect the occurrence of unanticipated events.

Overview

We are a leading global provider of text imaging solutions. Our end-user and embedded solutions for print, web and mobile environments enable people to create and consume dynamic content on any and every device. Our technologies and fonts enable the

 

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display and printing of high quality digital text. Our software technologies have been widely deployed across, and embedded in, a range of consumer electronics, or CE, devices, including laser printers, digital copiers, mobile phones, navigation devices, digital cameras, e-book readers, digital televisions, set-top boxes and consumer appliances, as well as in numerous software applications and operating systems. In the laser printer market, we have worked together with industry leaders for over 19 years to provide critical components embedded in printing standards. Our scaling, compression, text layout, printer driver, page description languages, color and user interface technologies solve critical text imaging and user experience issues for CE device manufacturers by rendering high quality text, graphics and user interfaces on low resolution and memory constrained CE devices. We combine these proprietary technologies with access to more than 14,000 typefaces from a library of some of the most widely used designs in the world, including popular names such as Helvetica and Times New Roman. We also license our typefaces to creative and business professionals through our e-commerce websites fonts.com, linotype.com, ascenderfonts.com, itcfonts.com, fontmarketplace.com and webfonts.fonts.com, which combined attracted more than 35 million visits in 2010 from over 200 countries and territories, direct and indirect sales and custom font design services.

Sources of Revenue

We derive revenue from two principal sources: licensing our text imaging solutions to CE device manufacturers and independent software vendors, which we refer to as our OEM revenue, and licensing our fonts to creative and business professionals, which we refer to as our creative professional revenue. We derive our OEM revenue primarily from CE device manufacturers. We derive our creative professional revenue primarily from multinational corporations, graphic designers, media organizations, advertisers, printers and publishers. Traditionally, we have experienced, and we expect to continue to experience, lower revenue in the first half of the year due to the timing of some contractual payments of licensing fees from our OEM customers. Some of our revenue streams, particularly custom revenue, have historically been and we expect them to continue to be in the future, more susceptible to weakening economic conditions.

Geographic revenue, which is based on the location of our subsidiary receiving such revenue, is in the table below:

 

     Three Months Ended
June 30,
 
     2011     2010  
     Sales      % of Total     Sales      % of Total  
     (In thousands, except percentages)  

United States

   $ 13,921         44.8   $ 8,904         36.4

Asia

     10,684         34.4        10,718         43.9   

United Kingdom

     1,683         5.4        1,154         4.7   

Germany

     4,778         15.4        3,659         15.0   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 31,066         100.0   $ 24,435         100.0
  

 

 

    

 

 

   

 

 

    

 

 

 

 

 

     Six Months Ended
June 30,
 
     2011     2010  
     Sales      % of Total     Sales      % of Total  
     (In thousands, except percentages)  

United States

   $ 27,211         44.7   $ 17,831         36.5

Asia

     21,503         35.4        21,105         43.2   

United Kingdom

     2,803         4.6        2,468         5.0   

Germany

     9,278         15.3        7,492         15.3   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 60,795         100.0   $ 48,896         100.0
  

 

 

    

 

 

   

 

 

    

 

 

 

For the three months ended June 30, 2011 and 2010, sales by our subsidiaries located outside the United States comprised 55.2% and 63.6%, respectively, of our total revenue. For the six months ended June 30, 2011 and 2010, sales by our subsidiaries located outside the United States comprised 55.3% and 63.5%, respectively, of our total revenue. In the three and six months ended June 30, 2011, U.S. revenue as a percent of total revenue increased due to the Ascender acquisition and contractual changes with an existing customer. We expect that sales by our international subsidiaries will continue to represent a substantial portion of our revenue for the foreseeable future. Future international revenue will depend on the continued use and expansion of our text imaging solutions worldwide.

We derive a majority of our revenue from a limited number of customers, in particular manufacturers of laser printers and mobile phones. For the three months ended June 30, 2011 and 2010, our top ten licensees by revenue accounted for approximately 47.5% and 51.7% of our total revenue, respectively. For the six months ended June 30, 2011 and 2010, our top ten licensees by revenue accounted for approximately 46.4% and 50.9% of our total revenue, respectively. Although no one customer accounted for more than 10% of our total revenue for the three or six months ended June 30, 2011 or 2010, if we are unable to maintain relationships with major customers or establish relationships with new customers, our licensing revenue will be adversely affected.

 

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OEM Revenue

Our OEM revenue is derived substantially from per-unit royalties for printer imaging, display imaging and printer driver, or driver, products. Under our licensing arrangements, we typically receive a royalty for each product unit incorporating our text imaging solutions that is shipped by our OEM customers. We also receive OEM revenue from fixed fee licenses with certain of our OEM customers. Fixed fee licensing arrangements are not based on units the customer ships, but instead, customers pay us on a periodic basis for use of our text imaging solutions. Though significantly less than royalties from per-unit shipments and fixed fees from OEM customers, we also receive revenue from software application and operating systems vendors who include our text imaging solutions in their products and for font development. Many of our licenses continue so long as our OEM customers ship products that include our technology, unless terminated for breach. Other licenses have terms that range from three to five years and usually provide for automatic or optional renewals. Revenue from per-unit royalties is recognized in the period during which we receive a royalty report from a customer, typically one quarter after royalty-bearing units are shipped. Revenue from fixed fee licenses is generally recognized when it is billed to the customer, so long as the product has been delivered, the license fee is fixed and non-refundable and collection is probable.

Creative Professional Revenue

Our creative professional revenue is derived from font licenses and from custom font design services. We license fonts directly to end-users through our e-commerce websites, via telephone, email and indirectly through third-party resellers. We also license fonts and provide custom font design services to graphic designers, advertising agencies, media organizations and corporations. We refer to direct, indirect and custom revenue, as non-web revenue, and refer to revenue that is derived from our websites, as web revenue.

Revenue from font licenses to our e-commerce customers is recognized upon payment by the customer and electronic shipment of the software embodying the font. Revenue from font licenses to other customers is recognized upon shipment of the software embodying the font and when all other revenue recognition criteria have been met. Revenue from resellers is recognized upon notification from the reseller that our font product has been licensed and when all other revenue recognition criteria have been met. Custom font design services are generally recognized upon delivery. Contract accounting may be used where appropriate.

Cost of Revenue

Our cost of revenue consists of font license fees that we pay on certain fonts that are owned by third parties, allocated internal engineering expense and overhead costs directly related to custom design services. License fees that we pay to third parties are typically based on a percentage of our OEM and creative professional revenue and do not involve minimum fees. Our cost of OEM revenue is typically lower than our cost of creative professional revenue because we own a higher percentage of the fonts licensed to our OEM customers, provide value-added technology and have negotiated lower royalty rates on the fonts we license from third parties because of volume. The cost of our custom design service revenue is substantially higher than the cost of our other revenue and, as a result, our gross margin varies from period-to-period depending on the level of custom design revenue recorded.

Cost of revenue also includes amortization of acquired technology, which we amortize over 8 to 15 years. For purposes of amortizing acquired technology we estimate the remaining useful life of the technology based upon various considerations, including our knowledge of the technology and the way our customers use it. We use the straight-line method to amortize our acquired technology. There is no reliable evidence to suggest that we should expect any other pattern of amortization than an even pattern, and we believe this best reflects the expected pattern of economic usage.

Gross Profit

Our gross profit percentage is influenced by a number of factors including product mix, pricing and volume at any particular time. However, our cost of OEM revenue is typically lower than our cost of creative professional revenue because we own a higher percentage of the fonts licensed to our OEM customers, provide value-added technology and have negotiated lower royalty rates on the fonts we license from third parties because of volume. Within our creative professional business, the cost of our custom design service revenue is substantially higher than the cost of our other revenue. As a result, our gross profit varies from period-to-period depending on the mix between, and within, OEM and creative professional revenue.

Critical Accounting Policies

The preparation of financial statements and related disclosures in conformity with GAAP and our discussion and analysis of our financial condition and results of operations requires us to make judgments, assumptions and estimates that affect the amounts reported in our consolidated financial statements and accompanying notes. We base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances, the results of which form the basis for judgments about the carrying values of assets and liabilities. Actual results may differ from these estimates.

There has been no material change in our critical accounting policies since December 31, 2010. Information about our critical accounting policies may be found in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of

 

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Operations,” under the heading “Critical Accounting Policies,” of our Annual Report on Form 10-K for the year ended December 31, 2010.

Results of Operations for the Three Months Ended June 30, 2011 Compared to Three Months Ended June 30, 2010

The following table sets forth items in the condensed consolidated quarterly statement of income as a percentage of sales for the periods indicated:

 

     Three Months Ended
June 30,
 
     2011     2010  

Revenue:

    

OEM

     73.7     75.2

Creative professional

     26.3        24.8   
  

 

 

   

 

 

 

Total revenue

     100.0        100.0   

Cost of revenue

     9.5        7.8   

Cost of revenue—amortization of acquired technology

     2.6        3.6   
  

 

 

   

 

 

 

Total cost of revenue

     12.1        11.4   
  

 

 

   

 

 

 

Gross profit

     87.9        88.6   

Marketing and selling

     26.5        25.4   

Research and development

     12.7        14.5   

General and administrative

     13.3        16.7   

Amortization of other intangible assets

     4.2        4.9   
  

 

 

   

 

 

 

Total operating expenses

     56.7        61.5   
  

 

 

   

 

 

 

Income from operations

     31.2        27.1   

Interest expense, net

     2.7        4.5   

(Gain) loss on foreign exchange

     (0.2     6.9   

Loss (gain) on derivatives

     1.1        (4.1
  

 

 

   

 

 

 

Total other expense

     3.6        7.3   

Income before provision for income taxes

     27.6        19.8   

Provision for income taxes

     9.6        7.3   
  

 

 

   

 

 

 

Net income

     18.0     12.5
  

 

 

   

 

 

 

The following discussion compares the three months ended June 30, 2011 with the three months ended June 30, 2010.

Sales by Segment. We view our operations and manage our business as one segment: the development, marketing and licensing of technologies and fonts. Factors used to identify our single segment include the financial information available for evaluation by our chief operating decision maker in making decisions about how to allocate resources and assess performance. While our technologies and services are sold to customers in two principal markets (CE device manufacturers and independent software vendors, together OEM, and creative professional), expenses and assets are not formally allocated to these markets, and operating results are assessed on an aggregate basis to make decisions about the allocation of resources.

The following table presents revenue for these two principal markets (in thousands):

 

     Three Months Ended
June 30,
     Increase  
     2011      2010     

OEM

   $ 22,885       $ 18,387       $ 4,498   

Creative professional

     8,181         6,048         2,133   
  

 

 

    

 

 

    

 

 

 

Total revenue

   $ 31,066       $ 24,435       $ 6,631   
  

 

 

    

 

 

    

 

 

 

Revenue

Revenue was $31.1 million and $24.4 million for the three months ended June 30, 2011 and 2010, respectively, an increase of $6.6 million, or 27.1%.

OEM revenue increased $4.5 million, or 24.5%, to $22.9 million for the three months ended June 30, 2011, as compared to $18.4 million for the three months ended June 30, 2010, mainly due to an increase in display imaging revenue. Display imaging

 

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revenue increased due to increased volume of unit shipments of products by our customers, such as OEMs and independent software vendors, who embed our fonts and technology solutions.

Creative professional revenue was $8.2 million and $6.0 million for the three months ended June 30, 2011 and 2010, respectively, an increase of $2.2 million, or 35.3%, primarily due to an increase in non-web revenue. Non-web revenue, which includes direct, indirect and custom revenue, increased primarily a result of increased direct sales to our enterprise customers and custom revenue.

Cost of Revenue and Gross Profit

Cost of revenue, excluding amortization of acquired technology, was $3.0 million and $1.9 million for the three months ended June 30, 2011 and 2010, respectively, an increase of $1.1 million. As a percentage of total revenue, cost of revenue, excluding amortization of acquired technology, was 9.5% and 7.8% in the three months ended June 30, 2011 and 2010, respectively. The increase in cost of revenue in dollars was partially the result of product mix and higher sales volume. The increase as a percentage of revenue was due to product mix. In the three months ended June 30, 2011, as compared to the same period in 2010, a portion of our OEM revenue had higher associated costs. A portion of our OEM revenue in the three months ended June 30, 2011, included costs related to service work performed in connection with the revenue, as compared to the same period in 2010. This, coupled with a higher percentage of creative professional revenue in the second quarter of 2011, contributed to the increase in cost of revenue, as compared to the same period in 2010. OEM revenue represented 73.7% of our total revenue in the three months ended June 30, 2011 as compared to 75.2% in the same period in 2010. Creative professional revenue typically has a higher associated cost than our OEM revenue.

The portion of cost of revenue consisting of amortization of acquired technology was $0.8 million and $0.9 million for the three months ended June 30, 2011 and 2010, respectively.

Gross profit was 87.9% of sales in the three months ended June 30, 2011, as compared to 88.6% in the three months ended June 30, 2010, a decrease of 0.7%, mainly the result of the aforementioned factors. Our gross profit percentage is influenced by a number of factors including product mix, pricing and volume at any particular time.

Operating Expenses

Marketing and Selling. Marketing and selling expense was $8.2 million and $6.2 million in the three months ended June 30, 2011 and 2010, respectively, an increase of $2.0 million, or 32.7%. Personnel costs increased $1.1 million in the three months ended June 30, 2011, as compared to the same period in 2010 mainly due to an increase in headcount. Headcount increased 13.3%; a result of a few key new hires and from our recent acquisition of Ascender. Online advertising increased $0.3 million in the second quarter of 2011, as compared to the same period in 2010 the direct result of conducting additional sales promotions. Increased discretionary spending for travel related costs and outside services contributed $0.4 million to the overall increase in marketing and selling expense.

Research and Development. Research and development expense was $3.9 million in the three months ended June 30, 2011, as compared to $3.6 million in the same period in 2010, an increase of $0.3 million or 10.2%. Personnel costs increased $0.5 million in the three months ended June 30, 2011, as compared to the same period in 2010 mainly due to an increase in headcount. Headcount increased 15.5% at June 30, 2011, as compared to June 30, 2010, part of which is attributable to our focus on strategic initiatives and the remainder, or 46% is the result of our Ascender acquisition. Personnel expense increases were partially offset by a $0.2 million increase in reclassifications to cost of revenue for service work performed on revenue recognized during the second quarter of 2011, as compared to the same period in 2010.

General and Administrative. General and administrative expense was $4.1 million in both of the three month periods ended June 30, 2011 and 2010, respectively. General and administrative expense was consistent period-over-period.

Amortization of Other Intangible Assets. Amortization of other intangible assets was $1.3 million and $1.2 million in the three months ended June 30, 2011 and 2010, respectively.

Interest Expense, Net

Interest expense, net of interest income decreased $0.2 million, or 22.4%, to $0.9 million for the three months ended June 30, 2011, as compared to $1.1 million for the three months ended June 30, 2010. The decrease is the result of lower total debt outstanding in the second quarter of 2011, as compared to the same period in 2010. Total debt outstanding, net of unamortized financing costs and debt discounts, at June 30, 2011 was $57.3 million, as compared to $81.2 million at June 30, 2010.

(Gain) Loss on Foreign Exchange

(Gain) loss on foreign exchange was a gain of $0.1 million and a loss of $1.7 million in the three months ended June 30, 2011 and 2010, respectively, an increase of $1.8 million, primarily due to currency fluctuations on our Euro denominated intercompany note.

 

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Loss (Gain) on Derivatives

Loss (gain) on derivatives was a loss of $0.4 million and a gain of $1.0 million in the three months ended June 30, 2011 and 2010, respectively, a decrease of $1.4 million, the net result of changes to the market value of our swap contracts, particularly the currency swap. See the table in Note 5 for details regarding the loss (gain) on derivatives balance.

Provision for Income Taxes

For the three months ended June 30, 2011 and 2010, our effective tax rate was 34.7% and 37.0%, respectively. During the second quarter of 2011, our effective tax rate included a 0.9% benefit from research credits, which was not included in the same period in 2010 due to the scheduled expiration of such credits under the Internal Revenue Code. The research credit was subsequently reinstated in the fourth quarter of 2010. Our effective state tax rate, net of federal benefit, for the second quarter of 2011 was 1.2%, as compared to 1.9% for the same period in 2010, a decrease of 0.7%. During the three months ended June 30, 2011, the effective rate included 0.8% for permanent non-deductible share based compensation expense, as compared to 1.0% for the same period in 2010. Our effective tax rate in the three months ended June 30, 2011 also includes a benefit of 0.7% related to the exercise of stock options, as compared to 0.5% for the same period in 2010.

Results of Operations for the Six Months Ended June 30, 2011 Compared to Six Months Ended June 30, 2010

The following table sets forth items in the condensed consolidated year-to-date statement of income as a percentage of sales for the periods indicated:

 

     Six Months Ended
June 30,
 
     2011     2010  

Revenue:

    

OEM

     73.7     73.6

Creative professional

     26.3        26.4   
  

 

 

   

 

 

 

Total revenue

     100.0        100.0   

Cost of revenue

     8.2        7.6   

Cost of revenue—amortization of acquired technology

     2.6        3.6   
  

 

 

   

 

 

 

Total cost of revenue

     10.8        11.2   
  

 

 

   

 

 

 

Gross profit

     89.2        88.8   

Marketing and selling

     26.4        24.9   

Research and development

     13.3        15.5   

General and administrative

     13.6        16.6   

Amortization of other intangible assets

     4.3        4.9   
  

 

 

   

 

 

 

Total operating expenses

     57.6        61.9   
  

 

 

   

 

 

 

Income from operations

     31.6        26.9   

Interest expense, net

     2.8        4.7   

Loss on foreign exchange

     (0.8     5.4   

(Gain) loss on derivatives

     1.7        (3.6
  

 

 

   

 

 

 

Total other expense

     3.7        6.5   

Income before provision for income taxes

     27.9        20.4   

Provision for income taxes

     9.7        7.5   
  

 

 

   

 

 

 

Net income

     18.2     12.9
  

 

 

   

 

 

 

The following discussion compares the six months ended June 30, 2011 with the six months ended June 30, 2010.

Sales by Segment. The following table presents revenue for these two principal markets (in thousands):

 

     Six Months Ended
June 30,
     Increase  
     2011      2010     

OEM

   $ 44,783       $ 36,008       $ 8,775   

Creative professional

     16,012         12,888         3,124   
  

 

 

    

 

 

    

 

 

 

Total revenue

   $ 60,795       $ 48,896       $ 11,899   
  

 

 

    

 

 

    

 

 

 

 

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Revenue

Revenue was $60.8 million and $48.9 million for the six months ended June 30, 2011 and 2010, respectively, an increase of $11.9 million, or 24.3%.

OEM revenue was $44.8 million and $36.0 million for the six months ended June 30, 2011 and 2010, respectively, an increase of $8.8 million, or 24.4%, mainly due to an increase in display imaging revenue. Display imaging revenue increased due to increased volume of unit shipments of products by our customers, such as OEMs and independent software vendors, who embed our fonts and technology solutions.

Creative professional revenue increased $3.1 million or 24.3%, to $16.0 million for the six months ended June 30, 2011, as compared to $12.9 million for the six months ended June 30, 2010. Non-web revenue, which includes direct, indirect and custom revenue, increased primarily a result of increased direct sales to our enterprise customers and custom revenue.

Cost of Revenue and Gross Profit

Cost of revenue excluding amortization of acquired technology was $5.0 million and $3.7 million for the six months ended June 30, 2011 and 2010, respectively, an increase of $1.3 million, or 33.8%. As a percentage of total revenue, cost of revenue excluding amortization was 8.2% and 7.6% in the six months ended June 30, 2011 and 2010, respectively. The increase in cost of revenue in dollars was partially the result of product mix and higher sales volume. The increase as a percentage of revenue was due to product mix. In the six months ended June 30, 2011, as compared to the same period in 2010, a greater portion of our OEM revenue had higher associated costs.

Amortization of acquired technology was $1.6 million and $1.7 million for the six months ended June 30, 2011 and 2010, respectively, a decrease from 3.6% to 2.6% of revenue.

Gross profit was 89.2% in the six months ended June 30, 2011, as compared to 88.8% in the six months ended June 30, 2010, an increase of 0.4%, mainly the result of the aforementioned factors. Our gross profit percentage is influenced by a number of factors including product mix, pricing and volume at any particular time.

Operating Expenses

Marketing and Selling. Marketing and selling expense increased $3.9 million, or 31.6%, to $16.0 million in the six months ended June 30, 2011 as compared to $12.2 million in the six months ended June 30, 2010. Personnel expenses increased $2.1 million, the result of an increase in headcount. Headcount increased 13.3% a result of a few key new hires and from our recent acquisition of Ascender. Online advertising expense increased $0.7 million in the first half of 2011, as compared to the same period in 2010, partially due to targeted advertising for our new web font services product and partially the result of our efforts to increase traffic to our websites. Increased discretionary spending on travel related expenses and outside services contributed $0.7 million to the overall increase in the six months ended June 30, 2011, as compared to the same period in 2010. Other expenses related to processing fees on web sales resulted in increased expenses of $0.2 million.

Research and Development. Research and development expense increased $0.5 million, or 6.2%, to $8.1 million in the six months ended June 30, 2011, as compared to $7.6 million in the six months ended June 30, 2010 primarily due to an increase in personnel expenses. Personnel related expenses increased $0.7 million in the first half of 2011, as compared to the same period in 2010, mainly a result of an increase in headcount. Headcount increased 15.5% at June 30, 2011, as compared to June 30, 2010, as we continue to focus on our strategic initiatives and partially the result of our Ascender acquisition. Personnel expense increases were partially offset by a $0.4 million increase in reclassifications to cost of sales for service work on revenue recognized during the first half of the year. Travel related expenses increased $0.2 million in the first half of 2011, as compared to the same period in 2010, the result of an increase in discretionary spending for attendance at tradeshows.

General and Administrative. General and administrative expense was $8.3 million and $8.1 million in the six months ended June 30, 2011 and 2010, respectively, an increase of $0.2 million, or 3.0%, mainly the result of an increase in professional service expenses and personnel related expenses.

Amortization of Other Intangible Assets. Amortization of other intangible assets was $2.6 million and $2.4 million in the six month ended June 30, 2011 and 2010, respectively, an increase of $0.2 million, mainly due to our acquisition of Ascender.

Interest Expense, Net

Interest expense, net of interest income was $1.7 million for the six months ended June 30, 2011, as compared to $2.3 million for the six months ended June 30, 2010, a decrease of $0.6 million, or 24.1%. The decrease is the result of lower total debt outstanding in the first half of 2011, as compared to the same period in 2010. Total debt outstanding, net of unamortized financing costs and debt discounts, at June 30, 2011 was $57.3 million, as compared to $81.2 million at June 30, 2010.

 

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(Gain) Loss on Foreign Exchange

(Gain) loss on foreign exchange was a gain of $0.5 million and a loss of $2.7 million for the six months ended June 30, 2011 and 2010, respectively, an increase of $3.2 million, primarily due to our Euro denominated intercompany note. For the six months ended June 30, 2011, we recorded a gain of $0.8 million on the note compared to a loss of $2.4 million for the six months ended June 30, 2010.

Loss (Gain) on Derivatives

Loss (gain) on derivatives was a loss of $1.0 million and a gain of $1.8 million for the six months ended June 30, 2011 and 2010, respectively, a decrease of $2.8 million. In the first half of 2011, $0.9 million of the loss relates to our currency swap contract and the remaining $0.1 million relates to our interest rate swap contract. In the first half of 2010, we recorded a gain of $2.3 million on our currency swap contract and a loss of $0.5 million on our interest rate swap contracts. See the table in Note 5 for details regarding the loss (gain) on derivatives balance.

Provision for Income Taxes

For the six months ended June 30, 2011 and 2010, our effective tax rate was 34.8% and 36.8%, respectively. During the first half of 2011, our effective tax rate included a 0.9% benefit from research credits, which was not included in the same period in 2010 due to the scheduled expiration of such credits under the Internal Revenue Code. The research credit was subsequently reinstated in the fourth quarter of 2010. Our effective state tax rate, net of federal benefit, decreased 0.7% in the six months ended June 30, 2011 as compared to the same period in 2010. The effective rate decreased 0.3% in the first half of 2011, for share based compensation expense.

Liquidity and Capital Resources

Cash Flows for the Six Months Ended June 30, 2011 and 2010

Since our inception, we have financed our operations primarily through cash from operations, private and public stock sales and long-term debt arrangements, as described below. We believe our existing cash and cash equivalents, our cash flow from operating activities and available bank borrowings will be sufficient to meet our anticipated cash needs for at least the next twelve months. At June 30, 2011, our principal sources of liquidity were cash and cash equivalents totaling $53.1 million and a $20.0 million revolving line-of-credit which was undrawn at June 30, 2011 and December 31, 2010, however, availability under the line-of-credit was reduced by approximately $4.0 million at both June 30, 2011 and December 31, 2010 as a result of our outstanding derivative instruments with our lender. In June 2011 we made a voluntary prepayment of $5.0 million. In March 2010, we made mandatory prepayments of $5.2 million under our Amended and Restated Credit Agreement; no such payment was required in March 2011. See Note 16 regarding the refinancing of our debt. Our future working capital requirements will depend on many factors, including the operations of our existing business, our potential strategic expansion and future acquisitions we might undertake. To the extent that our cash and cash equivalents, our current debt arrangements and our cash flow from operating activities are insufficient to fund our future activities, we may need to raise additional funds through bank credit arrangements or public or private equity or debt financings.

The following table presents our cash flows from operating activities, investing activities and financing activities for the periods presented (in thousands):

 

     Six Months Ended
June 30,
 
     2011     2010  

Net cash provided by operating activities

   $ 17,469      $ 21,918   

Net cash used in investing activities

     (791     (2,189

Net cash used in financing activities

     (6,477     (9,712

Effect of exchange rates on cash and cash equivalents

     73        39   
  

 

 

   

 

 

 

Total increase in cash and cash equivalents

   $ 10,274      $ 10,056   
  

 

 

   

 

 

 

Operating Activities

Significant variations in operating cash flows may occur because, from time-to-time, our customers make prepayments against future royalties. Prepayments may be required under the terms of our license agreements and are occasionally made on an elective basis and often cause large fluctuations in accounts receivable and deferred revenue. The timing and extent of such prepayments significantly impacts our cash balances.

We generated $17.5 million in cash from operations during the six months ended June 30, 2011. Net income, after adjusting for depreciation and amortization, amortization of deferred financing costs, loss on retirement of fixed assets, share based compensation, excess tax benefit on stock options, provision for doubtful accounts, deferred income taxes, unrealized currency gain on foreign denominated intercompany transactions, and unrealized loss on derivatives generated $19.5 million in cash. Deferred revenue

 

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generated $3.1 million in cash, mainly the result of the receipt of a large royalty prepayment. Increases in accounts receivable, prepaid expenses and other assets and decreases in accounts payable, and accrued income taxes used $2.8 million in cash. Decreases in accrued expense and other liabilities used $2.3 million in cash, as a result of the payment of variable compensation accrued in previous periods.

We generated $21.9 million in cash from operations during the six months ended June 30, 2010. Net income, after adjusting for depreciation and amortization, loss on retirement of fixed assets, amortization of financing costs, share based compensation, excess tax benefit on stock options, provision for doubtful accounts, deferred income taxes, unrealized currency loss on foreign denominated intercompany transactions and gain on derivatives, generated $14.7 million in cash. Deferred revenue provided $4.4 million in cash, resulting primarily from the receipt of two large royalty prepayments. Collections on accounts receivable, decreases in prepaid expenses and other assets and increases in accounts payable and accrued expenses and other liabilities provided $2.7 million in cash.

Investing Activities

In the six months ended June 30, 2011, cash used in investing activities consisted of purchases of property and equipment. In the six month period ended June 30, 2010, cash used in investing activities consisted of purchases of an exclusive license and the purchase of property and equipment.

Financing Activities

Cash used in financing activities for the six months ended June 30, 2011 was $6.5 million. Payments on long-term debt used $8.9 million in cash, offset by $1.5 million in cash received from stock option exercises and $0.9 million related to the excess tax benefit on stock options for the six months ended June 30, 2011. Cash used in financing activities for the six months ended June 30, 2010 was $9.7 million. Payments on long-term debt used $10.6 million in cash, offset by $0.5 million in cash received from stock option exercises and $0.4 million related to the excess tax benefit on stock options for the six months ended June 30, 2010.

Credit Facility

On July 13, 2011 we entered into a five-year $120.0 million revolving credit facility (the “Credit Facility”). See Note 16 for details regarding the Credit Facility. The Credit Facility replaces the Amended and Restated Credit Agreement, which terminated effective July 13, 2011. In connection with the refinancing, the Company incurred closing fees of $0.8 million plus legal fees of approximately $0.4 million. In accordance with ASC Subtopic No. 470-50, Modifications and Extinguishments of Debt, these fees will be accounted for as deferred financing costs and will be amortized to interest expense over the term of the Credit Facility. In addition, approximately $0.4 million of unamortized deferred financing costs associated with the pro-rata share of prior loan syndicate lenders that did not participate in the Credit Facility will be written off and charged to other expense in the third quarter of 2011.

On July 30, 2007, in connection with our initial public offering, we entered into our Amended and Restated Credit Agreement. The principal amount of our term loan was increased to $140.0 million payable in monthly installments of approximately $1.2 million throughout the term of the facility, which expired in July 2012. The Amended and Restated Credit Agreement provided for an additional annual mandatory principal payment based on excess cash flow, as defined in the agreement, to be paid within five days of the delivery of our audited financial statements. This additional annual principal prepayment is not mandatory when the leverage ratio falls below 2.00:1.00. At December 31, 2010, the leverage ratio was 1.40:1.00. Accordingly, we were not required to and did not make an additional payment following the delivery of our audited financial statements in March 2011. The Amended and Restated Credit Agreement was secured by substantially all of our assets and places limitations on indebtedness, liens, dividends and distributions, asset sales, transactions with affiliates and acquisitions and conduct of business, all as defined in the agreements. On October 30, 2009 we entered into a second amendment to our Amended and Restated Credit Agreement primarily to permit us to use up to $15.0 million of cash per year for acquisitions. The definition of Adjusted EBITDA was amended to permit add backs for restructuring expenses and certain non-operating and non-cash items. In connection with this amendment, we made a $5.0 million principal payment on our debt. The margin rate of prime and LIBOR borrowings were increased to 2.25% and 3.75%, respectively, which reflected a one percentage point increase to each rate. In addition we paid a fee of $0.6 million which is being amortized over the remaining life of the debt. A minimum liquidity requirement was added that required us to maintain a minimum level of Available Cash, which is defined as cash held in U.S. banks, plus available borrowings under our line of credit. On December 30, 2010, the Company entered into a third amendment, or the Third Amendment, to our Amended and Restated Credit Agreement. The Third Amendment permitted the Company to repurchase shares of its capital stock pursuant to repurchase agreements or similar agreements approved by the Company’s Board of Directors, provided that such distributions shall not exceed $5.0 million in any period of two consecutive fiscal quarters, and $10.0 million in the aggregate. In connection with the Third Amendment, the Company made a principal prepayment of $10.0 million without incurring a prepayment penalty.

Interest rates on borrowings under the Amended and Restated Credit Agreement were at either (i) the prime rate plus 2.25%, as defined in the credit agreement, or (ii) LIBOR plus a 3.75%, payable monthly. As of June 30, 2011, the blended interest rate on the

 

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Amended and Restated Credit Agreement was 3.95%. In addition, the Amended and Restated Credit Agreement provided that we maintain a maximum leverage ratio. The leverage ratio is defined as the ratio of aggregate outstanding indebtedness to trailing twelve months Adjusted EBITDA. Adjusted EBITDA is defined as consolidated net earnings (or loss), plus net interest expense, income taxes, depreciation and amortization and share based compensation expense, plus restructuring, issuance costs, cash non-operating costs and other expenses or losses minus cash non-operating gains and other non-cash gains; provided however that the aggregate of all cash non-operating expense shall not exceed $250 thousand and all such fees, costs and expenses shall not exceed $1.5 million on a trailing twelve months basis. As of June 30, 2011, the maximum leverage ratio permitted was 2.75:1.00 and our leverage ratio was 1.07:1.00. We were also in compliance with the minimum liquidity requirement, with Available Cash, as defined in the Amended and Restated Credit Agreement, of $63.4 million. The Amended and Restated Credit Agreement also contained a no material adverse change clause.

The following table presents a reconciliation from net income, which is the most directly comparable GAAP operating performance measure, to EBITDA and from EBITDA to Adjusted EBITDA as defined in our credit facilities (in thousands):

 

     Three Months Ended
June 30,
     Six Months Ended
June 30,
 
     2011      2010      2011      2010  

Net income

   $ 5,598       $ 3,044       $ 11,038       $ 6,306   

Provision for income taxes

     2,971         1,788         5,893         3,665   

Interest expense, net

     860         1,108         1,739         2,290   

Depreciation and amortization

     2,363         2,305         4,667         4,648   
  

 

 

    

 

 

    

 

 

    

 

 

 

EBITDA

   $ 11,792       $ 8,245       $ 23,337       $ 16,909   

Share based compensation

     1,753         1,474         3,322         2,811   

Non-cash add backs

     42         447         73         552   

Restructuring, issuance and cash non-operating costs(2)

     116         35         228         347   

Acquisition expenses

     —           —           94         —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Adjusted EBITDA(1)

   $ 13,703       $ 10,201       $ 27,054       $ 20,619   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Adjusted EBITDA is not a measure of operating performance under GAAP and should not be considered as an alternative or substitute for GAAP profitability measures such as income (loss) from operations and net income (loss). Adjusted EBITDA as an operating performance measure has material limitations since it excludes the statement of income impact of depreciation and amortization expense, interest expense, net, the provision (benefit) for income taxes and share based compensation and therefore does not represent an accurate measure of profitability, particularly in situations where a company is highly leveraged or has a disadvantageous tax structure. We have significant intangible assets and amortization expense is a meaningful element in our financial statements and therefore its exclusion from Adjusted EBITDA is a material limitation. We have a significant amount of debt, and interest expense is a necessary element of our costs and therefore its exclusion from Adjusted EBITDA is a material limitation. We generally incur significant U.S. federal, state and foreign income taxes each year and the provision for income taxes is a necessary element of our costs and therefore its exclusion from Adjusted EBITDA is a material limitation. We have share based compensation and the associated expense has a meaningful impact on our financial statements and therefore its exclusion from Adjusted EBITDA is a material limitation. Non-cash expenses, restructuring, issuance and cash non-operating expenses have a meaningful impact on our financial statements. Therefore, their exclusion from Adjusted EBITDA is a material limitation. As a result, Adjusted EBITDA should be evaluated in conjunction with net income for complete analysis of our profitability, as net income includes the financial statement impact of these items and is the most directly comparable GAAP operating performance measure to Adjusted EBITDA. As Adjusted EBITDA is not defined by GAAP, our definition of Adjusted EBITDA may differ from and therefore may not be comparable to similarly titled measures used by other companies, thereby limiting its usefulness as a comparative measure. Because of the limitations that Adjusted EBITDA has as an analytical tool, investors should not consider it in isolation, or as a substitute for analysis of our operating results as reported under GAAP.
(2) Permits an add-back of up to $250 thousand of cash non-operating expense, which is not to exceed $1.5 million when combined together with restructuring and issuance costs.

The Amended and Restated Credit Agreement also contained provisions for an increased interest rate during periods of default. We do not believe that these covenants will affect our ability to operate our business, and we were in compliance with the covenants under our Amended and Restated Credit Agreement as of June 30, 2011.

Non-GAAP Measures

In addition to Adjusted EBITDA as discussed above, we rely internally on certain measures that are not calculated according to GAAP. This non-GAAP measure is net adjusted EBITDA, which is defined as income (loss) from operations before depreciation, amortization of acquired intangible assets and stock-based compensation expenses. We use net adjusted EBITDA as a principal indicator of the operating performance of our business. We use net adjusted EBITDA in internal

 

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forecasts and models when establishing internal operating budgets, supplementing the financial results and forecasts reported to our board of directors, determining bonus compensation for our employees based on operating performance and evaluating short-term and long-term operating trends in our operations. We believe that net adjusted EBITDA permits a comparative assessment of our operating performance, relative to our performance based on our GAAP results, while isolating the effects of charges that may vary from period-to-period without direct correlation to underlying operating performance. We believe that these non-GAAP financial adjustments are useful to investors because they allow investors to evaluate the effectiveness of the methodology and information used by management in our financial and operational decision-making. We believe that trends in our net adjusted EBITDA may be valuable indicators of our operating performance.

The following table presents a reconciliation from income from operations, which is the most directly comparable GAAP operating financial measure, to net adjusted EBITDA as used by management (in thousands):

 

     Three Months Ended
June  30,
     Six Months Ended
June 30,
 
     2011      2010      2011      2010  

Income from operations

   $ 9,695       $ 6,624       $ 19,212       $ 13,176   

Depreciation and amortization

     2,363         2,305         4,667         4,648   

Share based compensation

     1,753         1,474         3,322         2,811   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net adjusted EBITDA (1)

   $ 13,811       $ 10,403       $ 27,201       $ 20,635   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Net adjusted EBITDA is not a measure of operating performance under GAAP and should not be considered as an alternative or substitute for GAAP profitability measures such as income (loss) from operations and net income (loss). Net adjusted EBITDA as an operating performance measure has material limitations since it excludes the statement of income impact of depreciation and amortization expense and share based compensation and therefore does not represent an accurate measure of profitability. We have significant intangible assets and amortization expense is a meaningful element in our financial statements and therefore its exclusion from net adjusted EBITDA is a material limitation. Share based compensation and the associated expense has a meaningful impact on our financial statements and therefore its exclusion from net adjusted EBITDA is a material limitation. As a result, net adjusted EBITDA should be evaluated in conjunction with income (loss) from operations for complete analysis of our profitability, as income (loss) from operations includes the financial statement impact of these items and is the most directly comparable GAAP operating performance measure to net adjusted EBITDA. As net adjusted EBITDA is not defined by GAAP, our definition of net adjusted EBITDA may differ from and therefore may not be comparable to similarly titled measures used by other companies, thereby limiting its usefulness as a comparative measure. Because of the limitations that net adjusted EBITDA has as an analytical tool, investors should not consider it in isolation, or as a substitute for analysis of our operating results as reported under GAAP.

Recently Issued Accounting Pronouncements

Comprehensive Income

In June 2011, the FASB issued ASC Topic No. 220, Comprehensive Income, which amended its guidance on the presentation of comprehensive income in financial statements to improve the comparability, consistency and transparency of financial reporting and to increase the prominence of items that are recorded in other comprehensive income. The new accounting guidance requires entities to report components of comprehensive income in either (1) a single statement of comprehensive income immediately following the income statement or (2) a separate statement of comprehensive income immediately following the income statement. Companies will no longer be allowed to present comprehensive income on the statement of changes in shareholders’ equity. In both options, companies must present the components of net income, total net income, the components of other comprehensive income, total other comprehensive income and total comprehensive income. The provisions of this new guidance are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011 and will require retrospective application for all periods presented. We are currently evaluating the impact of adopting this guidance on our financial statements.

Fair Value Measurements and Disclosures

In January 2010, the FASB issued ASC Topic No. 820, Fair Value Measurements and Disclosures, (“ASC 820”). ASC 820 improves disclosures about fair value measurements, requiring disclosures about valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements (class Level 2 or Level 3). Details regarding each class level, as defined by ASC 820, can be found in Note 5. In addition, more details are required regarding significant transfers between Levels 1 and 2 and the reasons for these transfers. New disclosures and clarifications regarding existing disclosures are effective for interim and annual reporting periods beginning after December 15, 2009, except for details regarding purchases, sales, issuances and settlements in the activity roll forward of class Level 3 which is effective for fiscal periods beginning after December 15, 2010 and interim periods within those fiscal periods. We adopted the first provision of ASC 820 and the adoption did not have a material impact on the

 

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Company’s results of operations, financial position or liquidity. The Company adopted the second provision of ASC 820 on January 1, 2011 and the adoption did not have a material impact on its results of operations, financial position or liquidity.

Multiple-Deliverable Revenue Arrangements

In October 2009, the FASB approved for issuance ASC Subtopic No. 605-25, Revenue Recognition Multiple-Element Arrangements, (“ASC 605-25”). ASC 605-25 provides principles for allocation of consideration among its multiple-elements, allowing more flexibility in identifying and accounting for separate deliverables under an arrangement. It introduces an estimated selling price method for valuing the elements of a bundled arrangement if vendor-specific objective evidence or third-party evidence of selling price is not available, and significantly expands related disclosure requirements. ASC 605-25 is effective on a prospective basis for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. Alternatively, adoption may be on a retrospective basis, and early application is permitted. The Company adopted ASC 605-25 on January 1, 2011 and the adoption did not have an impact on its results of operations, financial position or liquidity for all periods presented.

 

Item 3. Quantitative and Qualitative Disclosures about Market Risk

We are exposed to financial market risk, including interest rate risk and foreign currency exchange risk.

Concentration of Revenue and Credit Risk

Financial instruments that potentially subject us to concentrations of credit risk consist principally of cash and cash equivalents and trade receivables. Cash equivalents consist primarily of bank deposits and certain investments, such as commercial paper, corporate securities and municipal securities, with maturities less than 90 days or containing seven day guaranteed put features to the issuer. Deposits of cash held outside the United States totaled approximately $1.8 million and $2.2 million at June 30, 2011 and December 31, 2010, respectively.

We grant credit to customers in the ordinary course of business. Credit evaluations are performed on an ongoing basis to reduce credit risk, and no collateral is required from our customers. An allowance for uncollectible accounts is provided for those accounts receivable considered to be uncollectible based upon historical experience and credit evaluation. As of June 30, 2011, two customers individually accounted for 17.3% and 12.2%, respectively, of our gross accounts receivable. As of December 31, 2010, two customers each individually accounted for 12% of our gross accounts receivable. Due to the nature of our quarterly revenue streams derived from royalty revenue, it is not unusual for our accounts receivable balances to include a few customers with large balances. Historically, we have not recorded material losses due to customers’ nonpayment.

For the three and six months ended June 30, 2011 and 2010, no customer accounted for more than 10% of our revenue.

Derivative Financial Instruments and Interest Rate Risk

We use interest rate derivative instruments to hedge our exposure to interest rate volatility resulting from our variable rate debt. ASC Topic No.815, Derivatives and Hedging, or ASC 815, requires that all derivative instruments be reported on the balance sheet at fair value and establishes criteria for designation and effectiveness of hedging relationships, including a requirement that all designations must be made at the inception of each instrument. As we did not make such initial designations, ASC 815 requires changes in the fair value of the derivative instrument to be recognized as current period income or expense.

The fair value of derivative instruments is estimated based on the amount that we would receive or pay to terminate the agreements at the reporting date. Our exposure to market risk associated with changes in interest rates relates primarily to our long term debt. The interest rate on our Amended and Restated Credit Agreement fluctuates with either the prime rate or the LIBOR interest rate. At June 30, 2011, the blended rate of interest on our outstanding debt was 3.95%. For each one percent increase in interest rates our interest expense would increase by $0.6 million; however, this would be mitigated by our interest rate swap. We purchase interest rate swap instruments to hedge our exposure to interest rate fluctuations on our debt obligations. On May 24, 2010, we entered into a long term interest rate swap contract to pay a fixed rate of interest of 1.5% in exchange for a floating rate interest payment tied to the one-month LIBOR beginning January 2011. The contract has a notional amount of $50.0 million with a $20.0 million reduction in the notional amount in 2012 and matures on July 30, 2012. The total fair value of this financial instrument at June 30, 2011, and December 31, 2010, was a liability of approximately $0.5 million and $0.6 million, respectively. In the three months ended June 30, 2011 and 2010 we recognized losses of $0.1 million and $0.4 million, respectively. In the six months ended June 30, 2011 and 2010, we recognized losses of $0.1 million and $0.5 million, respectively. The losses have been included in loss (gain) on derivatives in the accompanying condensed consolidated statements of income.

Foreign Currency Exchange Rate Risk

In accordance with ASC Topic No. 830, Foreign Currency Matters, or ASC 830, all assets and liabilities of our foreign subsidiaries whose functional currency is a currency other than U.S. dollars are translated into U.S. dollars at an exchange rate as of

 

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the balance sheet date. Revenue and expenses of these subsidiaries are translated at the average monthly exchange rates. The resulting translation adjustments as calculated from the translation of our foreign subsidiaries to U.S. dollars are recorded as a separate component of stockholders’ equity.

We also incur foreign currency exchange gains and losses related to certain customers that are invoiced in U.S. dollars, but who have the option to make an equivalent payment in their own functional currencies at a specified exchange rate as of a specified date. In the period from that date until payment in the customer’s functional currency is received and converted into U.S. dollars, we can incur unrealized gains and losses. To mitigate our exposure we utilize forward contracts with maturities of 90 days or less to hedge our exposure to these currency fluctuations. Any increase or decrease in the fair value of the forward contracts is offset by the change in the value of the hedged assets of our consolidated foreign affiliate. At June 30, 2011 and December 31, 2010 there were no currency contracts outstanding.

In addition, we incur foreign currency exchange rate gains and losses on an intercompany note with one of our foreign subsidiaries that is denominated in Euros. At June 30, 2011, the note balance was approximately $8.7 million. The effect of an immediate 10% strengthening of the U.S. dollar as compared to the Euro would result in a $0.9 million unrealized transaction loss on this note receivable which would be reported in (gain) loss on foreign exchange within our results of operations; however, this would be mitigated by our currency swap. On May 7, 2008, we entered into a long term currency swap contract to purchase 18.3 million Euros in exchange for $28.0 million to mitigate our exposure to currency fluctuation risk on this note. The contract payment terms approximate the payment terms of this intercompany note and the notional amount is amortized down over time as payments are made. For the three months ended June 30, 2011 and 2010, we incurred a loss of $0.3 million and a gain of $1.4 million, respectively. For the six months ended June 30, 2011 and 2010, we incurred a loss of $0.9 million and a gain of $2.3 million, respectively, on the currency swap contract. The gains and losses on the currency swap are included in loss (gain) on derivatives in the accompanying condensed consolidated statements of income.

Losses and (gains) on the intercompany note are included in (gain) loss on foreign exchange in the accompanying condensed statements of income, and were a net gain of $0.2 million and a net loss of $1.4 million for the three months ended June 30, 2010 and 2009, respectively. In the six months ended June 30, 2011 and 2010, we incurred a net gain of $0.8 million and a net loss of $2.4 million, respectively, on the intercompany note.

 

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our principal executive officer and principal financial officer, evaluated the effectiveness of our disclosure controls and procedures as of June 30, 2011. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Securities and Exchange Act of 1934, as amended, or the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives, and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Our disclosure controls and procedures are designed to provide a reasonable assurance of achieving their objectives.

Based on the evaluation of our disclosure controls and procedures as of June 30, 2011, our principal executive officer and principal financial officer concluded that, as of such date, the Company’s disclosure controls and procedures were effective at the reasonable assurance level.

Changes in Internal Control Over Financial Reporting

There was no change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the fiscal quarter ended June 30, 2011 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

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Part II—OTHER INFORMATION

 

Item 1. Legal Proceedings

From time to time, we may be a party to various claims, suits and complaints. We are not currently a party to any legal proceedings that, if determined adversely to us, would have a material adverse effect on our business, results of operations or financial condition.

 

Item 1A. Risk Factors

Except as noted below, there are no material changes in our risk factors from those disclosed in Part I, Item 1A of our annual report on Form 10-K for the year ended December 31, 2010.

We conduct a substantial portion of our business outside North America and, as a result, we face diverse risks related to engaging in international business.

We have offices in five foreign countries and we are dedicating a significant portion of our sales efforts in countries outside North America. We are dependent on international sales for a substantial amount of our total revenue. In the three months ended June 30, 2011 and 2010, approximately 55.2% and 63.6%, respectively, of our total revenue was derived from operations outside the U.S and we expect that international sales will continue to represent a substantial portion of our revenue for the foreseeable future. This future international revenue will depend on the continued use and expansion of our text imaging solutions, including the licensing of our technologies and fonts worldwide.

In the three months ended June 30, 2011 and 2010, revenue from our Asian subsidiaries was 34.4% and 43.9%, respectively, which is principally from customers located in Japan through our Japanese office. Although nothing has come to our attention indicating that the impact of the recent earthquakes and tsunami in Japan will have a material impact on our business, the ultimate extent of the impact is presently unknown. Many of our OEM printer customers are large, global organizations, and it is unclear how much of their printer production is dependent upon suppliers or manufacturing facilities located in Japan. If our OEM customers, including any of our printer customers, experience interruptions in their manufacturing process as a result of the recent events in Japan, unit sales of their products could temporarily decline, which in turn would result in a corresponding decline in our royalty revenue. As our OEM customers report royalties to us one quarter in arrears, the impact, if any, will not be known until at least our quarter ending September 30, 2011.

We are subject to the risks of conducting business internationally, including:

 

   

our ability to enforce our contractual and intellectual property rights, especially in those foreign countries that do not respect and protect intellectual property rights to the same extent that the United States does, which increases the risk of unauthorized and uncompensated use of our text imaging solutions;

 

   

United States and foreign government trade restrictions, including those that may impose restrictions on importation of programming, technology or components to or from the United States;

 

   

foreign government taxes, regulations and permit requirements, including foreign taxes that we may not be able to offset against taxes imposed upon us in the United States, and foreign tax and other laws limiting our ability to repatriate funds to the United States;

 

   

foreign labor laws, regulations and restrictions;

 

   

changes in diplomatic and trade relationships;

 

   

difficulty in staffing and managing foreign operations;

 

   

political instability, natural disasters—including the impact of the earthquakes and related events in Japan, war and/or events of terrorism; and

 

   

the strength of international economies.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

(a) Unregistered Sales of Equity Securities

None.

(b) Use of proceeds

Not applicable.

 

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(c) Purchases of Equity Securities by the Issuer and Affiliated Purchasers

From time to time, the Company may repurchase unvested restricted stock pursuant to the terms of its equity award plans. There were no repurchases of our equity securities made by us or on our behalf, or by any “affiliated purchasers” during the quarter ended June 30, 2011.

 

Item 3. Defaults Upon Senior Securities

Not applicable.

 

Item 4. Removed and Reserved

 

Item 5. Other Information

None.

 

Item 6. Exhibits

The exhibits listed in the Exhibit Index immediately preceding the exhibits are filed as part of this Quarterly Report on Form 10-Q and such Exhibit Index is incorporated herein by reference.

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

    MONOTYPE IMAGING HOLDINGS INC.
Date: August 2, 2011     By:   /S/    DOUGLAS J. SHAW        
       

Douglas J. Shaw

President, Chief Executive Officer and Director

(Principal Executive Officer)

Date: August 2, 2011     By:   /S/    SCOTT E. LANDERS        
       

Scott E. Landers

Senior Vice President, Chief Financial Officer, Treasurer and

Assistant Secretary (Principal Financial Officer)

 

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EXHIBIT INDEX

Listed and indexed below are all exhibits filed as part of this report.

 

Exhibit No.

  

Description

10.1    Form of Non-Qualified Stock Option Agreement under the Amended and Restated 2007 Option and Incentive Plan *
10.2    Form of Incentive Stock Option Agreement under the Amended and Restated 2007 Option and Incentive Plan *
10.3    Form of Restricted Stock Agreement under the Amended and Restated 2007 Option and Incentive Plan *
10.4    Amended and Restated 2007 Stock Option and Incentive Plan (1)
10.5    Credit Agreement by and among Monotype Imaging Holdings Inc., as Parent, Monotype Imaging Inc., as Borrower, the Lenders (as defined therein) and Wells Fargo Capital Finance, LLC, as Agent, dated as of July 13, 2011. (2)
10.6    General Continuing Guaranty by and among the Guarantors (as defined therein) and Wells Fargo Capital Finance, LLC, dated as of July 13, 2011. (2)
10.7    Security Agreement by and among the Grantors (as defined therein) and Wells Fargo Capital Finance, LLC, dated as of July 13, 2011. (2)
31.1    Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, by Chief Executive Officer. *
31.2    Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, by Chief Financial Officer. *
32.1    Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, by Chief Executive Officer and Chief Financial Officer. *
101.INS    XBRL Instance Document**
101.SCH    XBRL Taxonomy Extension Schema Document**
101.CAL    XBRL Taxonomy Extension Calculation Linkbase Document**
101.LAB    XBRL Taxonomy Extension Label Linkbase Document**
101.PRE    XBRL Taxonomy Extension Presentation Linkbase Document**

 

(1) Incorporated by reference to the Company’s Registration Statement on Form S-8 filed on May 17, 2011.
(2) Incorporated by reference to the Company’s Current Report on Form 8-K filed on July 19, 2011.
* Filed herewith.
** XBRL (Extensible Business Reporting Language) information is furnished and not filed or a part of a registration statement or prospectus for purposes of sections 11 or 12 of the Securities Act of 1933, as amended, is deemed not filed for purposes of section 18 of the Securities Exchange Act of 1934, as amended, and otherwise is not subject to liability under these sections.

 

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