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 JuneSeptember 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 JulyOctober 27, 2011 was 36,032,535.36,021,986.
MONOTYPE IMAGING HOLDINGS INC.
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Item | Management’s Discussion and Analysis of Financial Condition and Results of Operations | ||||||||||
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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 | September 30, 2011 | December 31, 2010 | |||||||||||||
Assets | ||||||||||||||||
Current assets: | ||||||||||||||||
Cash and cash equivalents | $ | 53,060 | $ | 42,786 | $ | 51,478 | $ | 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 | ||||||||||||||
Accounts receivable, net of allowance for doubtful accounts of $142 at September 30, 2011 and $92 at December 31, 2010 | 6,680 | 4,720 | ||||||||||||||
Income tax refunds receivable | 440 | 340 | 468 | 340 | ||||||||||||
Deferred income taxes | 436 | 350 | 306 | 350 | ||||||||||||
Prepaid expenses and other current assets | 2,297 | 2,480 | ||||||||||||||
Prepaid expense and other current assets | 2,578 | 2,480 | ||||||||||||||
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Total current assets | 62,313 | 50,676 | 61,510 | 50,676 | ||||||||||||
Property and equipment, net | 1,925 | 1,589 | 2,290 | 1,589 | ||||||||||||
Goodwill | 145,843 | 142,354 | 142,326 | 142,354 | ||||||||||||
Intangible assets, net | 77,021 | 80,239 | 74,047 | 80,239 | ||||||||||||
Other assets | 4,175 | 3,947 | 5,566 | 3,947 | ||||||||||||
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Total assets | $ | 291,277 | $ | 278,805 | $ | 285,739 | $ | 278,805 | ||||||||
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Liabilities and Stockholders’ Equity | ||||||||||||||||
Current liabilities: | ||||||||||||||||
Accounts payable | $ | 513 | $ | 753 | $ | 487 | $ | 753 | ||||||||
Accrued expenses and other current liabilities | 9,842 | 13,045 | 10,030 | 13,045 | ||||||||||||
Accrued income taxes | — | 1,171 | 254 | 1,171 | ||||||||||||
Deferred revenue | 11,300 | 8,506 | 10,892 | 8,506 | ||||||||||||
Current portion of long-term debt | 10,000 | 8,355 | 10,000 | 8,355 | ||||||||||||
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Total current liabilities | 31,655 | 31,830 | 31,663 | 31,830 | ||||||||||||
Long-term debt, less current portion | 47,344 | 57,504 | 37,321 | 57,504 | ||||||||||||
Other long-term liabilities | 765 | 471 | 257 | 471 | ||||||||||||
Deferred income taxes | 22,372 | 19,328 | 21,594 | 19,328 | ||||||||||||
Reserve for income taxes, net of current portion | 1,238 | 1,125 | 1,139 | 1,125 | ||||||||||||
Accrued pension benefits | 3,993 | 3,565 | 3,760 | 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 | ||||||||||||||
Common stock, $0.001 par value, Authorized shares: 250,000,000; Issued: 36,090,933 at September 30, 2011 and 35,490,331 at December 31, 2010 | 36 | 35 | ||||||||||||||
Additional paid-in capital | 161,489 | 155,791 | 163,803 | 155,791 | ||||||||||||
Treasury stock, at cost, 98,183 shares at June 30, 2011 and 95,516 shares at December 31, 2010 | (86 | ) | (86 | ) | ||||||||||||
Treasury stock, at cost, 98,527 shares at September 30, 2011 and 95,516 shares at December 31, 2010 | (86 | ) | (86 | ) | ||||||||||||
Retained earnings | 19,355 | 8,317 | 25,347 | 8,317 | ||||||||||||
Accumulated other comprehensive income | 3,116 | 925 | 905 | 925 | ||||||||||||
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Total stockholders’ equity | 183,910 | 164,982 | 190,005 | 164,982 | ||||||||||||
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Total liabilities and stockholders’ equity | $ | 291,277 | $ | 278,805 | $ | 285,739 | $ | 278,805 | ||||||||
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The accompanying notes are an integral part of these condensed consolidated financial statements.
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, | Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||||||||||||||||
2011 | 2010 | 2011 | 2010 | 2011 | 2010 | 2011 | 2010 | |||||||||||||||||||||||||
Revenue | $ | 31,066 | $ | 24,435 | $ | 60,795 | $ | 48,896 | $ | 30,695 | $ | 28,358 | $ | 91,490 | $ | 77,254 | ||||||||||||||||
Costs and expenses: | ||||||||||||||||||||||||||||||||
Cost of revenue | 2,961 | 1,910 | 4,987 | 3,728 | 2,503 | 1,825 | 7,490 | 5,553 | ||||||||||||||||||||||||
Cost of revenue—amortization of acquired technology | 798 | 868 | 1,575 | 1,739 | 798 | 869 | 2,373 | 2,608 | ||||||||||||||||||||||||
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Total cost of revenue | 3,759 | 2,778 | 6,562 | 5,467 | 3,301 | 2,694 | 9,863 | 8,161 | ||||||||||||||||||||||||
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Gross profit | 27,307 | 21,657 | 54,233 | 43,429 | 27,394 | 25,664 | 81,627 | 69,093 | ||||||||||||||||||||||||
Operating expenses: | ||||||||||||||||||||||||||||||||
Marketing and selling | 8,231 | 6,204 | 16,029 | 12,178 | 8,169 | 6,731 | 24,198 | 18,909 | ||||||||||||||||||||||||
Research and development | 3,933 | 3,570 | 8,060 | 7,591 | 4,116 | 3,934 | 12,176 | 11,525 | ||||||||||||||||||||||||
General and administrative | 4,144 | 4,072 | 8,337 | 8,096 | 4,284 | 4,104 | 12,621 | 12,200 | ||||||||||||||||||||||||
Amortization of other intangible assets | 1,304 | 1,187 | 2,595 | 2,388 | 1,252 | 1,189 | 3,847 | 3,577 | ||||||||||||||||||||||||
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Total operating expenses | 17,612 | 15,033 | 35,021 | 30,253 | 17,821 | 15,958 | 52,842 | 46,211 | ||||||||||||||||||||||||
Income from operations | 9,695 | 6,624 | 19,212 | 13,176 | 9,573 | 9,706 | 28,785 | 22,882 | ||||||||||||||||||||||||
Other (income) expense: | ||||||||||||||||||||||||||||||||
Interest expense | 885 | 1,108 | 1,801 | 2,303 | 587 | 1,084 | 2,388 | 3,387 | ||||||||||||||||||||||||
Interest income | (25 | ) | — | (62 | ) | (13 | ) | (29 | ) | — | (91 | ) | (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 | ) | ||||||||||||||||||||||||||
Loss (gain) on foreign exchange | 215 | (1,202 | ) | (266 | ) | 1,487 | ||||||||||||||||||||||||||
(Gain) loss on derivatives | (536 | ) | 1,597 | 487 | (168 | ) | ||||||||||||||||||||||||||
Loss on extinguishment of debt | 422 | — | 422 | — | ||||||||||||||||||||||||||||
Other expense (income), net | 2 | — | 2 | (9 | ) | |||||||||||||||||||||||||||
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Total other expense | 1,126 | 1,792 | 2,281 | 3,205 | 661 | 1,479 | 2,942 | 4,684 | ||||||||||||||||||||||||
Income before provision for income taxes | 8,569 | 4,832 | 16,931 | 9,971 | 8,912 | 8,227 | 25,843 | 18,198 | ||||||||||||||||||||||||
Provision for income taxes | 2,971 | 1,788 | 5,893 | 3,665 | 2,920 | 2,304 | 8,813 | 5,969 | ||||||||||||||||||||||||
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Net income | $ | 5,598 | $ | 3,044 | $ | 11,038 | $ | 6,306 | $ | 5,992 | $ | 5,923 | $ | 17,030 | $ | 12,229 | ||||||||||||||||
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Net income available to common stockholders – basic & diluted | $ | 5,502 | $ | 3,022 | $ | 10,861 | $ | 6,266 | ||||||||||||||||||||||||
Net income available to common shareholders—basic & diluted | $ | 5,891 | $ | 5,886 | $ | 16,753 | $ | 12,152 | ||||||||||||||||||||||||
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Net income per common share: | ||||||||||||||||||||||||||||||||
Basic | $ | 0.16 | $ | 0.09 | $ | 0.31 | $ | 0.18 | $ | 0.17 | $ | 0.17 | $ | 0.48 | $ | 0.35 | ||||||||||||||||
Diluted | $ | 0.15 | $ | 0.08 | $ | 0.30 | $ | 0.17 | $ | 0.16 | $ | 0.16 | $ | 0.46 | $ | 0.34 | ||||||||||||||||
Weighted average number of shares: | ||||||||||||||||||||||||||||||||
Basic | 35,308,941 | 34,727,219 | 35,176,156 | 34,651,885 | 35,447,484 | 35,208,237 | 35,267,592 | 34,710,406 | ||||||||||||||||||||||||
Diluted | 36,772,515 | 35,992,541 | 36,638,697 | 35,924,077 | 36,829,518 | 36,264,638 | 36,703,298 | 35,910,668 |
The accompanying notes are an integral part of these condensed consolidated financial statements.
MONOTYPE IMAGING HOLDINGS INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited and in thousands)
Six Months Ended June 30, | Nine Months Ended September 30, | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Cash flows from operating activities | ||||||||||||||||
Net income | $ | 11,038 | $ | 6,306 | $ | 17,030 | $ | 12,229 | ||||||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||||||||||
Depreciation and amortization | 4,667 | 4,648 | 6,987 | 6,966 | ||||||||||||
Loss on retirement of fixed assets | — | 3 | 2 | 3 | ||||||||||||
Amortization of deferred financing costs | 340 | 423 | 403 | 614 | ||||||||||||
Loss on extinguishment of debt | 422 | — | ||||||||||||||
Share based compensation | 3,322 | 2,811 | 5,128 | 4,206 | ||||||||||||
Excess tax benefit on stock options | (898 | ) | (395 | ) | (1,046 | ) | (533 | ) | ||||||||
Provision for doubtful accounts | 71 | 16 | 95 | 68 | ||||||||||||
Deferred income taxes | 559 | 526 | 855 | 749 | ||||||||||||
Unrealized currency (gain) loss on foreign denominated intercompany transactions | (451 | ) | 2,140 | (124 | ) | 1,043 | ||||||||||
Unrealized loss (gain) on derivatives | 885 | (1,820 | ) | 326 | (237 | ) | ||||||||||
Changes in operating assets and liabilities: | ||||||||||||||||
Accounts receivable | (1,217 | ) | 627 | (1,932 | ) | 1,033 | ||||||||||
Income tax refunds receivable | (100 | ) | — | |||||||||||||
Prepaid expenses and other assets | (113 | ) | 590 | 521 | 876 | |||||||||||
Accounts payable | (253 | ) | 562 | (274 | ) | (81 | ) | |||||||||
Accrued income taxes | (1,161 | ) | 147 | (857 | ) | 1,113 | ||||||||||
Income tax refunds receivable | 6 | — | ||||||||||||||
Accrued expenses and other liabilities | (2,303 | ) | 943 | (1,474 | ) | 2,694 | ||||||||||
Deferred revenue | 3,083 | 4,391 | 2,169 | 4,965 | ||||||||||||
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Net cash provided by operating activities | 17,469 | 21,918 | 28,237 | 35,708 | ||||||||||||
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Cash flows from investing activities | ||||||||||||||||
Purchases of property and equipment | (791 | ) | (189 | ) | (1,462 | ) | (633 | ) | ||||||||
Acquisition, net of cash acquired | (219 | ) | — | |||||||||||||
Purchase of exclusive license | — | (2,000 | ) | — | (3,000 | ) | ||||||||||
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Net cash used in investing activities | (791 | ) | (2,189 | ) | (1,681 | ) | (3,633 | ) | ||||||||
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Cash flows from financing activities | ||||||||||||||||
Payments on long-term debt | (8,855 | ) | (10,583 | ) | (76,845 | ) | (13,438 | ) | ||||||||
Proceeds from issuance of debt, net of issuance costs | 56,065 | — | ||||||||||||||
Excess tax benefit on stock options | 898 | 395 | 1,046 | 533 | ||||||||||||
Proceeds from exercises of common stock options | 1,480 | 476 | 1,840 | 585 | ||||||||||||
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Net cash used in financing activities | (6,477 | ) | (9,712 | ) | (17,894 | ) | (12,320 | ) | ||||||||
Effect of exchange rates on cash and cash equivalents | 73 | 39 | 30 | 250 | ||||||||||||
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Increase in cash and cash equivalents | 10,274 | 10,056 | 8,692 | 20,005 | ||||||||||||
Cash and cash equivalents at beginning of period | 42,786 | 34,616 | 42,786 | 34,616 | ||||||||||||
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Cash and cash equivalents at end of period | $ | 53,060 | $ | 44,672 | $ | 51,478 | $ | 54,621 | ||||||||
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The accompanying notes are an integral part of these condensed consolidated financial statements.
MONOTYPE IMAGING HOLDINGS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JuneSeptember 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 softwareOur technologies and fonts have been widely deployed across, and embedded in, a range of consumer electronics or CE(“CE”) devices, including laser printers, digital copiers, mobile phones, navigation devices, digital cameras, e-book readers, automotive displays, tablets, digital televisions, set-top boxes and consumer appliances, as well as in numerous software applications and operating systems. The Company also provides printer drivers, page description language interpreters, printer user interface technology and color imaging solutions to printer manufacturers and OEMs (original equipment manufacturers). 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 JuneSeptember 30, 2011 and for the three and sixnine months ended JuneSeptember 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
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.million. 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$7.4 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.was completed in the third quarter of 2011. There were no significant changes to the initial purchase accounting during the quarter ended JuneSeptember 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”)LIBOR beginning January 2011November 28, 2010 to mitigate our exposure to interest rate fluctuations on our debt obligations for the remainder of the term of the note.obligations. 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 JuneSeptember 30, 2011 and December 31, 2010 was a liability of $0.5$0.4 million and $0.7 million, respectively. We did not designate thethis 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 isare 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 gainloss of $0.2$0.6 million and a net lossgain of $1.4$1.3 million on the intercompany note for the three months ended JuneSeptember 30, 2011 and 2010, respectively.respectively, on the intercompany note. In the sixnine months ended JuneSeptember 30, 2011 and 2010, we incurred a net gain of $0.8$0.2 million and a net loss of $2.4$1.0 million, respectively, on the intercompany note, which is included in (gain) loss on foreign exchange in the accompanying condensed consolidated statements of income.note. 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 JuneSeptember 30, 2011 and December 31, 2010 was an asset of approximately $0.5$0.9 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 long-term assets in ourthe accompanying condensed consolidated balance sheets.
The following table presents the losses and (gains) on our derivative financial instruments which are included in (gain) loss (gain) on derivatives in our accompanying condensed consolidated statements of income (in thousands):
Three Months Ended June 30, | Six Months Ended June 30, | Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||||||||||||||||
2011 | 2010 | 2011 | 2010 | 2011 | 2010 | 2011 | 2010 | |||||||||||||||||||||||||
Interest rate swaps | $ | 94 | $ | 384 | $ | 140 | $ | 485 | $ | 6 | $ | 354 | $ | 146 | $ | 839 | ||||||||||||||||
Currency swap | 257 | (1,392 | ) | 883 | (2,253 | ) | (542 | ) | 1,243 | 341 | (1,010 | ) | ||||||||||||||||||||
Other | — | — | — | 3 | — | — | — | 3 | ||||||||||||||||||||||||
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Total | $ | 351 | $ | (1,008 | ) | $ | 1,023 | $ | (1,765 | ) | $ | (536 | ) | $ | 1,597 | $ | 487 | $ | (168 | ) | ||||||||||||
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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. 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 JuneSeptember 30, 2011 or December 31, 2010.
6. Fair Value Measurements
Fair value is defined asbased on 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 establishedestablishes 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 companyCompany 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 September 30, 2011 | ||||||||||||||||||||||||||||||||
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) | ||||||||||||||||||||||||||||
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 | $ | — | $ | — | $ | 39 | $ | 39 | $ | — | $ | — | ||||||||||||||||
Cash equivalents—asset backed securities | 1,250 | — | 1,250 | — | ||||||||||||||||||||||||||||
Cash equivalents—commercial paper | 2,149 | — | 2,149 | — | 7,149 | — | 7,149 | — | ||||||||||||||||||||||||
Cash equivalents—corporate bonds | 3,013 | — | 3,013 | — | 1,821 | — | 1,821 | — | ||||||||||||||||||||||||
Cash equivalents—government securities | 4,196 | — | 4,196 | — | ||||||||||||||||||||||||||||
Cash equivalents—municipal bonds | 10,255 | — | 10,255 | — | 5,510 | — | 5,510 | — | ||||||||||||||||||||||||
Derivatives – currency swap, current portion | 275 | — | 275 | — | ||||||||||||||||||||||||||||
Derivatives – currency swap, long-term portion | 197 | — | 197 | — | ||||||||||||||||||||||||||||
Derivatives—currency swap, current portion | 700 | — | 700 | — | ||||||||||||||||||||||||||||
Derivatives—currency swap, long-term portion | 176 | — | 176 | — | ||||||||||||||||||||||||||||
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Total assets | $ | 20,443 | $ | 4,554 | $ | 15,889 | $ | — | $ | 20,841 | $ | 39 | $ | 20,802 | $ | — | ||||||||||||||||
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Liabilities: | ||||||||||||||||||||||||||||||||
Derivatives – interest rate swap, current portion | $ | 494 | $ | — | $ | 494 | $ | — | ||||||||||||||||||||||||
Derivatives – interest rate swap, long-term portion | 46 | — | 46 | — | ||||||||||||||||||||||||||||
Derivatives—interest rate swap, current portion | $ | 385 | $ | — | $ | 385 | $ | — | ||||||||||||||||||||||||
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Total liabilities | $ | 540 | $ | — | $ | 540 | $ | — | $ | 385 | $ | — | $ | 385 | $ | — | ||||||||||||||||
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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 JuneSeptember 30, 2011 the fair value of our long-term debt approximated its carrying value of $58.0$47.3 million. The Company’s non-financial assets and non-financial liabilities subject to non-recurring measuresmeasurements include goodwill and intangible assets.
7. Intangible Assets
Intangible assets consist of the following (dollar amounts in thousands):
June 30, 2011 | December 31, 2010 | Life (Years) | September 30, 2011 | December 31, 2010 | ||||||||||||||||||||||||||||||||||||||||||||||||||
Life (Years) | Gross Carrying Amount | Accumulated Amortization | Net Balance | Gross Carrying Amount | Accumulated Amortization | Net Balance | 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 | 7-15 | $ | 49,419 | $ | (29,966 | ) | $ | 19,453 | $ | 49,419 | $ | (26,413 | ) | $ | 23,006 | ||||||||||||||||||||||||
Acquired technology | 8-15 | 40,000 | (19,531 | ) | 20,469 | 39,846 | (17,878 | ) | 21,968 | 8-15 | 39,815 | (20,267 | ) | 19,548 | 39,846 | (17,878 | ) | 21,968 | ||||||||||||||||||||||||||||||||||||
Non-compete agreements | 3-6 | 12,150 | (11,661 | ) | 489 | 12,039 | (11,363 | ) | 676 | 3-6 | 12,039 | (11,612 | ) | 427 | 12,039 | (11,363 | ) | 676 | ||||||||||||||||||||||||||||||||||||
Trademarks | 30,695 | — | 30,695 | 30,189 | — | 30,189 | 30,219 | — | 30,219 | 30,189 | — | 30,189 | ||||||||||||||||||||||||||||||||||||||||||
Domain names | 4,400 | — | 4,400 | 4,400 | — | 4,400 | 4,400 | — | 4,400 | 4,400 | — | 4,400 | ||||||||||||||||||||||||||||||||||||||||||
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Total | $ | 137,156 | $ | (60,135 | ) | $ | 77,021 | $ | 135,893 | $ | (55,654 | ) | $ | 80,239 | $ | 135,892 | $ | (61,845 | ) | $ | 74,047 | $ | 135,893 | $ | (55,654 | ) | $ | 80,239 | ||||||||||||||||||||||||||
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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 | ) | ||||
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Total debt | 57,344 | 65,859 | ||||||
Less current portion | (10,000 | ) | (8,355 | ) | ||||
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Long-term debt | $ | 47,344 | $ | 57,504 | ||||
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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 | ||||||||||||
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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 | )% | ||||||||
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Reported income tax provision | $ | 2,971 | 34.7 | % | $ | 1,788 | 37.0 | % | ||||||||
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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 | )% | ||||||||
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Reported income tax provision | $ | 5,893 | 34.8 | % | $ | 3,665 | 36.8 | % | ||||||||
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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 | ) | ||||||||||
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Total comprehensive income | $ | 6,279 | $ | 940 | $ | 13,229 | $ | 2,803 | ||||||||
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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:
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 | ) | ||||||||
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Net income available to common shareholders—basic and diluted | $ | 5,502 | $ | 3,022 | $ | 10,861 | $ | 6,266 | ||||||||
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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 | ) | ||||||||
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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 | ||||||||||||
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Net income per share applicable to common shareholders—basic | $ | 0.16 | $ | 0.09 | $ | 0.31 | $ | 0.18 | ||||||||
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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 | ||||||||||||
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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 | ||||||||||||
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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 | ||||||||||||
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Total share based compensation | $ | 1,753 | $ | 1,474 | $ | 3,322 | $ | 2,811 | ||||||||
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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 | ||||||||||||
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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 | ||||||||||||
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Total | $ | 31,066 | 100.0 | % | $ | 24,435 | 100.0 | % | ||||||||
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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 | ||||||||||||
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Total | $ | 60,795 | 100.0 | % | $ | 48,896 | 100.0 | % | ||||||||
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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 | ||||||
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Total | $ | 224,789 | $ | 224,182 | ||||
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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.
16. Subsequent Events
On July 13, 2011 the Company entered into a new credit agreement with Wells Fargo Capital Finance, LLC, or the Credit Facility, and terminated its Amended and Restated Credit Agreement, which was scheduled to expire on July 30, 2012. The agreementCredit Facility provides the Company with a five-yearfive-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 LIBORLondon Interbank Offering Rate, (“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. At September 30, 2011 our rates, inclusive of applicable margins, were 2.5% and 5.5% for LIBOR and prime, respectively. At September 30, 2011, our blended interest rate was 2.5%. The Company is required to pay a commitmentan unused line 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 JuneSeptember 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 bewere written off and charged to other expense in the third quarter of 2011.
We are subject to a maximum leverage ratio and a fixed charge coverage ratio under the terms of our Credit Facility and we were in compliance with the covenants under our Credit Facility as of September 30, 2011.
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 statement of income were as follows (in thousands):
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Service cost | $ | 21 | $ | 20 | $ | 64 | $ | 60 | ||||||||
Interest cost | 45 | 40 | 138 | 123 | ||||||||||||
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Net periodic benefit cost | $ | 66 | $ | 60 | $ | 202 | $ | 183 | ||||||||
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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 September 30, | ||||||||||||||||
2011 | 2010 | |||||||||||||||
Provision for income taxes at statutory rate | $ | 3,119 | 35.0 | % | $ | 2,879 | 35.0 | % | ||||||||
State and local income taxes, net of federal tax benefit | 110 | 1.2 | % | 54 | 0.7 | % | ||||||||||
Stock compensation | 51 | 0.6 | % | 78 | 1.0 | % | ||||||||||
Research credits | (88 | ) | (1.0 | )% | — | — | ||||||||||
Effect of rate changes on deferred taxes | — | — | (158 | ) | (1.9 | )% | ||||||||||
Reversal of reserve for income taxes | (35 | ) | (0.4 | )% | (351 | ) | (4.3 | )% | ||||||||
Disqualifying dispositions on incentive stock options | (40 | ) | (0.5 | )% | (6 | ) | (0.1 | )% | ||||||||
Other, net | (197 | ) | (2.1 | )% | (192 | ) | (2.4 | )% | ||||||||
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Reported income tax provision | $ | 2,920 | 32.8 | % | $ | 2,304 | 28.0 | % | ||||||||
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Provision for income taxes at statutory rate State and local income taxes, net of federal tax benefit Stock compensation Research credits Effect of rate changes on deferred taxes Reversal of reserve for income taxes Disqualifying dispositions on incentive stock options Other, net Reported income tax provision Nine Months Ended September 30, 2011 2010 $ 9,045 35.0 % $ 6,369 35.0 % 318 1.2 % 240 1.3 % 179 0.7 % 183 1.0 % (231 ) (0.9 )% — — 9 — (158 ) (0.9 )% (35 ) (0.1 )% (351 ) (1.9 )% (135 ) (0.5 )% (76 ) (0.4 )% (337 ) (1.3 )% (238 ) (1.3 )% $ 8,813 34.1 % $ 5,969 32.8 %
At September 30, 2011 and December 31, 2010, the reserve for uncertain tax positions (including related interest) was approximately $1.1 million and $1.2 million, respectively.
11. Comprehensive Income
The components of comprehensive income are as follows (in thousands):
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Net income | $ | 5,992 | $ | 5,923 | $ | 17,030 | $ | 12,229 | ||||||||
Net changes in: | ||||||||||||||||
Foreign currency translation adjustment, net of tax of ($1,266), $1,533, ($21) and ($501), respectively | (2,211 | ) | 2,638 | (20 | ) | (865 | ) | |||||||||
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Total comprehensive income | $ | 3,781 | $ | 8,561 | $ | 17,010 | $ | 11,364 | ||||||||
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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,Earnings Per Share,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. |
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 September 30, | Nine Months Ended September 30, | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Numerator: | ||||||||||||||||
Net income, as reported | $ | 5,992 | $ | 5,923 | $ | 17,030 | $ | 12,229 | ||||||||
Less: net income attributable to participating securities | (101 | ) | (37 | ) | (277 | ) | (77 | ) | ||||||||
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Net income available to common shareholders—basic and diluted | $ | 5,891 | $ | 5,886 | $ | 16,753 | $ | 12,152 | ||||||||
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Denominator: | ||||||||||||||||
Basic: | ||||||||||||||||
Weighted-average shares of common stock outstanding | 36,053,462 | 35,426,859 | 35,852,081 | 34,929,708 | ||||||||||||
Less: weighted-average shares of unvested restricted common stock outstanding | (605,978 | ) | (218,622 | ) | (584,489 | ) | (219,302 | ) | ||||||||
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Weighted-average number of common shares used in computing basic net income per common share | 35,447,484 | 35,208,237 | 35,267,592 | 34,710,406 | ||||||||||||
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Net income per share applicable to common shareholders—basic | $ | 0.17 | $ | 0.17 | $ | 0.48 | $ | 0.35 | ||||||||
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Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Diluted: | ||||||||||||||||
Weighted-average shares of common stock outstanding | 36,053,462 | 35,426,859 | 35,852,081 | 34,929,708 | ||||||||||||
Less: weighted-average shares of unvested restricted common stock outstanding | (605,978 | ) | (218,622 | ) | (584,489 | ) | (219,302 | ) | ||||||||
Weighted-average number of common shares issuable upon exercise of outstanding stock options, based on the treasury stock method | 1,262,393 | 1,042,805 | 1,317,987 | 1,149,986 | ||||||||||||
Weighted-average number of restricted stock outstanding, based on the treasury stock method | 119,641 | 13,596 | 117,719 | 50,276 | ||||||||||||
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Weighted-average number of common shares used in computing diluted net income per common share | 36,829,518 | 36,264,638 | 36,703,298 | 35,910,668 | ||||||||||||
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Net income per share applicable to common shareholders—diluted | $ | 0.16 | $ | 0.16 | $ | 0.46 | $ | 0.34 | ||||||||
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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 September 30, | Nine Months Ended September 30, | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Options | 1,765,782 | 1,767,473 | 1,486,671 | 1,544,789 |
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 September 30, | Nine Months Ended September 30, | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Marketing and selling | $ | 777 | $ | 526 | $ | 2,172 | $ | 1,549 | ||||||||
Research and development | 414 | 277 | 1,187 | 892 | ||||||||||||
General and administrative | 615 | 592 | 1,769 | 1,765 | ||||||||||||
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Total share based compensation | $ | 1,806 | $ | 1,395 | $ | 5,128 | $ | 4,206 | ||||||||
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As of September 30, 2011, the Company had $13.0 million of unrecognized compensation expense, which is net of expected forfeitures, 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 2.0 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 September 30, | Nine Months Ended September 30, | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
OEM | $ | 23,047 | $ | 21,480 | $ | 67,830 | $ | 57,488 | ||||||||
Creative professional | 7,648 | 6,878 | 23,660 | 19,766 | ||||||||||||
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Total | $ | 30,695 | $ | 28,358 | $ | 91,490 | $ | 77,254 | ||||||||
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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 September 30, | ||||||||||||||||
2011 | 2010 | |||||||||||||||
Sales | % of Total | Sales | % of Total | |||||||||||||
(In thousands, except percentages) | ||||||||||||||||
United States | $ | 14,758 | 48.1 | % | $ | 10,448 | 36.8 | % | ||||||||
Asia | 10,259 | 33.4 | 11,357 | 40.1 | ||||||||||||
United Kingdom | 1,211 | 3.9 | 1,243 | 4.4 | ||||||||||||
Germany | 4,467 | 14.6 | 5,310 | 18.7 | ||||||||||||
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Total | $ | 30,695 | 100.0 | % | $ | 28,358 | 100.0 | % | ||||||||
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Nine Months Ended September 30, | ||||||||||||||||
2011 | 2010 | |||||||||||||||
Sales | % of Total | Sales | % of Total | |||||||||||||
(In thousands, except percentages) | ||||||||||||||||
United States | $ | 41,969 | 45.9 | % | $ | 28,279 | 36.6 | % | ||||||||
Asia | 31,762 | 34.7 | 32,462 | 42.0 | ||||||||||||
United Kingdom | 4,014 | 4.4 | 3,711 | 4.8 | ||||||||||||
Germany | 13,745 | 15.0 | 12,802 | 16.6 | ||||||||||||
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Total | $ | 91,490 | 100.0 | % | $ | 77,254 | 100.0 | % | ||||||||
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Long-lived assets, which include property and equipment, goodwill and intangibles 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):
September 30, 2011 | December 31, 2010 | |||||||
Long-lived assets: | ||||||||
United States | $ | 159,417 | $ | 164,213 | ||||
Asia | 3,316 | 3,402 | ||||||
United Kingdom | 52 | 31 | ||||||
Germany | 55,878 | 56,536 | ||||||
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Total | $ | 218,663 | $ | 224,182 | ||||
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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 September 30, 2011 and December 31, 2010.
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
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, automotive displays, tablets, 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 websitesfonts.com, linotype.com, ascenderfonts.com, itcfonts.com, fontmarketplace.comandwebfonts.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 where spending is largely discretionary in nature, 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 September 30, | ||||||||||||||||
2011 | 2010 | |||||||||||||||
Sales | % of Total | Sales | % of Total | |||||||||||||
(In thousands, except percentages) | ||||||||||||||||
United States | $ | 14,758 | 48.1 | % | $ | 10,448 | 36.8 | % | ||||||||
Asia | 10,259 | 33.4 | 11,357 | 40.1 | ||||||||||||
United Kingdom | 1,211 | 3.9 | 1,243 | 4.4 | ||||||||||||
Germany | 4,467 | 14.6 | 5,310 | 18.7 | ||||||||||||
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Total | $ | 30,695 | 100.0 | % | $ | 28,358 | 100.0 | % | ||||||||
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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 | ||||||||||||
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Total | $ | 31,066 | 100.0 | % | $ | 24,435 | 100.0 | % | ||||||||
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Six Months Ended June 30, | Nine Months Ended September 30, | |||||||||||||||||||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||||||||||||||||||
Sales | % of Total | Sales | % of Total | Sales | % of Total | Sales | % of Total | |||||||||||||||||||||||||
(In thousands, except percentages) | (In thousands, except percentages) | |||||||||||||||||||||||||||||||
United States | $ | 27,211 | 44.7 | % | $ | 17,831 | 36.5 | % | $ | 41,969 | 45.9 | % | $ | 28,279 | 36.6 | % | ||||||||||||||||
Asia | 21,503 | 35.4 | 21,105 | 43.2 | 31,762 | 34.7 | 32,462 | 42.0 | ||||||||||||||||||||||||
United Kingdom | 2,803 | 4.6 | 2,468 | 5.0 | 4,014 | 4.4 | 3,711 | 4.8 | ||||||||||||||||||||||||
Germany | 9,278 | 15.3 | 7,492 | 15.3 | 13,745 | 15.0 | 12,802 | 16.6 | ||||||||||||||||||||||||
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Total | $ | 60,795 | 100.0 | % | $ | 48,896 | 100.0 | % | $ | 91,490 | 100.0 | % | $ | 77,254 | 100.0 | % | ||||||||||||||||
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For the three months ended JuneSeptember 30, 2011 and 2010, sales by our subsidiaries located outside the United States comprised 55.2%51.9% and 63.6%63.2%, respectively, of our total revenue. For the sixnine months ended JuneSeptember 30, 2011 and 2010, sales by our subsidiaries located outside the United States comprised 55.3%54.1% and 63.5%63.4%, respectively, of our total revenue. In the three and sixnine months ended JuneSeptember 30, 2011, U.S. revenue as a percent of total revenue increased due to the Ascender acquisition and contractual changes with an existing customer. In the three and nine months ended September 30, 2011, we experienced a decrease in printer imaging royalty revenue from Asia primarily a result of the recent events in Japan. We recognize per-unit royalty revenue typically one quarter after our OEM customer ships product containing our royalty bearing units; consequently, the printer royalty revenue recognized in the third quarter of 2011 represents the time period directly after the recent natural disaster in Japan. We do, however, 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 JuneSeptember 30, 2011 and 2010, our top ten licensees by revenue accounted for approximately 47.5%46.1% and 51.7%51.2% of our total revenue, respectively. For the sixnine months ended JuneSeptember 30, 2011 and 2010, our top ten licensees by revenue accounted for approximately 46.4%46.2% and 50.9%50.5% of our total revenue, respectively. In the three months ended September 30, 2010 one customer accounted for 10.2% of our total revenue. Although no one customer accounted for more than 10% of our total revenue for the three or six months ended JuneSeptember 30, 2011 or nine months ended September 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.
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
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 JuneSeptember 30, 2011 Compared to Three Months Ended JuneSeptember 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 | ||||||
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Total revenue | 100.0 | 100.0 | ||||||
Cost of revenue | 9.5 | 7.8 | ||||||
Cost of revenue—amortization of acquired technology | 2.6 | 3.6 | ||||||
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Total cost of revenue | 12.1 | 11.4 | ||||||
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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 | ||||||
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Total operating expenses | 56.7 | 61.5 | ||||||
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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 | ) | |||||
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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 | ||||||
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Net income | 18.0 | % | 12.5 | % | ||||
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The following discussion compares the three months ended June 30, 2011 with the three months ended June 30, 2010.
Three Months Ended September 30, | ||||||||
2011 | 2010 | |||||||
Revenue: | ||||||||
OEM | 75.1 | % | 75.7 | % | ||||
Creative professional | 24.9 | 24.3 | ||||||
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Total revenue | 100.0 | 100.0 | ||||||
Cost of revenue | 8.2 | 6.4 | ||||||
Cost of revenue—amortization of acquired technology | 2.6 | 3.1 | ||||||
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Total cost of revenue | 10.8 | 9.5 | ||||||
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Gross profit | 89.2 | 90.5 | ||||||
Marketing and selling | 26.6 | 23.7 | ||||||
Research and development | 13.4 | 13.9 | ||||||
General and administrative | 13.9 | 14.5 | ||||||
Amortization of other intangible assets | 4.1 | 4.2 | ||||||
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Total operating expenses | 58.0 | 56.3 | ||||||
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Income from operations | 31.2 | 34.2 | ||||||
Interest expense, net | 1.8 | 3.8 | ||||||
Loss (gain) on foreign exchange | 0.7 | (4.2 | ) | |||||
(Gain) loss on derivatives | (1.7 | ) | 5.6 | |||||
Loss on extinguishment of debt | 1.4 | — | ||||||
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Total other expense | 2.2 | 5.2 | ||||||
Income before provision for income taxes | 29.0 | 29.0 | ||||||
Provision for income taxes | 9.5 | 8.1 | ||||||
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Net income | 19.5 | % | 20.9 | % | ||||
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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 | Three Months Ended September 30, | Increase | |||||||||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||||||||||
OEM | $ | 22,885 | $ | 18,387 | $ | 4,498 | $ | 23,047 | $ | 21,480 | $ | 1,567 | ||||||||||||
Creative professional | 8,181 | 6,048 | 2,133 | 7,648 | 6,878 | 770 | ||||||||||||||||||
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Total revenue | $ | 31,066 | $ | 24,435 | $ | 6,631 | $ | 30,695 | $ | 28,358 | $ | 2,337 | ||||||||||||
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Revenue
Revenue was $31.1$30.7 million and $24.4$28.4 million for the three months ended JuneSeptember 30, 2011 and 2010, respectively, an increase of $6.6$2.3 million, or 27.1%8.2%.
OEM revenue increased $4.5was $23.0 million or 24.5%, to $22.9and $21.5 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
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 JuneSeptember 30, 2011 and 2010, respectively, an increase of $2.2$1.5 million, or 35.3%,7.3%. Display imaging and driver revenue increased $2.7 million in the three months ended September 30, 2011, as compared to the same period in 2010 primarily due to increased license revenue from independent software vendors and customers in markets such as mobile phones and e-book readers. Decreased printer imaging royalty revenue, which we believe is mainly attributable to the recent events in Japan, partially offset these increases. Further discussion of the risk to our business is described in Part II, Item 1A, Risk Factors.
Creative professional revenue was $7.6 million and $6.9 million for the three months ended September 30, 2011 and 2010, respectively, an increase inof $0.8 million, or 11.2% due to both non-web revenue.and web revenue increases. Non-web revenue, which includes direct, indirect and custom revenue increased, primarily a result ofdue to increased direct sales to our enterprise customerscustomers. Web revenue also contributed to the increase primarily due to our newer product offerings, such as Font Explorer X and custom revenue.Web font services.
Cost of Revenue and Gross Profit
Cost of revenue, excluding amortization of acquired technology, was $3.0$2.5 million and $1.9$1.8 million for the three months ended JuneSeptember 30, 2011 and 2010, respectively, an increase of $1.1 million.$0.7 million or 37.0%. As a percentage of total revenue, cost of revenue, excluding amortization of acquired technology, was 9.5%8.2% and 7.8%6.4% in the three months ended JuneSeptember 30, 2011 and 2010, respectively. The increase in cost of revenue in dollars was partiallymainly the result of product mix and partially due to higher sales volume. The increase as a percentage of revenue was mainly due to variations in product mix. During the third quarter of 2011, reclassifications to cost of revenue for service work increased $0.2 million as compared to the same period in 2010. In the three months ended JuneSeptember 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.was derived from products that carry a higher royalty cost. OEM revenue represented 73.7%75.1% of our total revenue in the three months ended June 30,third quarter of 2011, as compared to 75.2%75.7% in the same period in 2010. Creative professionalOur OEM revenue typically has a higherlower associated cost than our OEMcreative professional 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 JuneSeptember 30, 2011 and 2010, respectively.
Gross profit was 87.9%89.2% of sales in the three months ended JuneSeptember 30, 2011, as compared to 88.6%90.5% in the three months ended JuneSeptember 30, 2010, a decrease of 0.7%,1.3 percentage points, 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$6.7 million in the three months ended JuneSeptember 30, 2011 and 2010, respectively, an increase of $2.0$1.5 million, or 32.7%21.4%. Personnel costsand personnel related expenses increased $1.1$0.9 million, in the three months ended June 30,third quarter of 2011, as compared to the same period in 2010, mainlypartially due to an increase in headcount.headcount and partially the result of higher salary expense due to annual increases. Headcount increased 13.3%5.6%; a result of a few key new hires and from our recent acquisition of Ascender. Online advertising increased, $0.3the direct result of conducting additional sales promotions, and increased discretionary spending for travel related costs together contributed $0.2 million to the overall increase in marketing and selling expense in the secondthird 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.2010.
Research and Development.Research and development expense was $4.1 million and $3.9 million in the three months ended JuneSeptember 30, 2011 as compared to $3.6 million in the same period inand 2010, respectively, an increase of $0.3$0.2 million or 10.2%4.6%. Personnel costsand personnel related expenses increased $0.5$0.2 million in the three months ended JuneSeptember 30, 2011, as compared to the same period in 2010, mainly due tothe result of an increase in headcount. HeadcountResearch and development headcount increased 15.5%15.0% at JuneSeptember 30, 2011, as compared to JuneSeptember 30, 2010, part of which is attributableas we continue to our focus on our strategic initiatives and the remainder, or 46% ispartially 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 secondthird quarter of 2011, as compared to the same period in 2010.2011. Increased professional service expenses contributed $0.2 million for outside contractors used for development work.
General and Administrative.General and administrative expense was $4.3 million and $4.1 million in both of the three month periodsmonths ended JuneSeptember 30, 2011 and 2010, respectively. Generalrespectively, an increase of $0.2 million, or 4.4%. The increase was mainly the result of an increase in legal related expenses primarily due to the timing of intellectual property registration actions and administrative expense was consistent period-over-period.increased professional service expenses.
Amortization of Other Intangible Assets. Amortization of other intangible assets was $1.3 million and $1.2 million infor the three months ended JuneSeptember 30, 2011 and 2010, respectively.respectively, an increase of $0.1 million or 5.3%.
Interest Expense, Net
Interest expense, net of interest income decreased $0.2was $0.6 million or 22.4%, to $0.9and $1.1 million forin the three months ended JuneSeptember 30, 2011 as compared to $1.1and 2010, respectively, a decrease of $0.5 million for the three months ended June 30, 2010.or 48.5%. The decrease isin interest expense was mainly the result of lower total debt outstanding incoupled with a lower interest rate on the second quarter of 2011, as compared to the same period in 2010.debt. Total debt outstanding, net of unamortized financing costs, and debt discounts, at JuneSeptember 30, 2011 was $57.3$45.9 million, as compared to $81.2$78.5 million at JuneSeptember 30, 2010. At September 30, 2011, the blended interest rate on our Credit Facility was 2.5%, as compared to a blended rate of 4.0% at September 30, 2010.
Loss (Gain) Loss on Foreign Exchange
(Gain) lossLoss (gain) on foreign exchange was a gain of $0.1 million and a loss of $1.7$0.2 million in the three months ended JuneSeptember 30, 2011, and 2010, respectively, an increase of $1.8 million, primarily dueas compared to currency fluctuations on our Euro denominated intercompany note.
Loss (Gain) on Derivatives
Loss (gain) on derivatives was a loss of $0.4 million and a gain of $1.0$1.2 million in the three months ended JuneSeptember 30, 2010, primarily from our Euro denominated intercompany note.
(Gain) Loss on Derivatives
(Gain) loss on derivatives was a gain of $0.5 million in the three months ended September 30, 2011, andas compared to a loss of $1.6 million in the three months ended September 30, 2010, respectively, a decrease of $1.4 million, the net result of changes to the market value of our swap contracts, particularlycontract. The gain in the third quarter of 2011 mainly related to our currency swap. Seeswap contract. In the table in Note 5 for details regarding the loss (gain)third quarter of 2010, we recorded losses of $1.2 million on derivatives balance.our currency swap contract and $0.4 million on our interest rate swap contracts.
Provision for Income Taxes
ForDuring the three months ended JuneSeptember 30, 2011 and 2010, our effective tax rate was 34.7%32.8% and 37.0%28.0%, respectively. During the secondthird quarter of 2011 ourthe effective tax rate included a 0.9% benefit from1.0% decrease for 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. OurDuring the third quarter of 2010, the effective state tax rate netincluded a 4.3% decrease due to the reversal of federal benefit,reserves for the second quarter of 2011 was 1.2%,income taxes, as compared to 1.9% for0.4% in the same period in 2010, a decreasethird quarter of 0.7%.2011. During the three months ended June 30, 2011,third quarter of 2010, 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 included a 1.9% decrease for the effect of rate changes on deferred taxes in the three months ended June 30, 2011 also includes a benefitthird quarter of 0.7% related to2010, which did not occur in the exercisethird quarter of stock options, as compared to 0.5% for the same period in 2010.2011.
Results of Operations for the SixNine Months Ended JuneSeptember 30, 2011 Compared to SixNine Months Ended JuneSeptember 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 | ||||||
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Total revenue | 100.0 | 100.0 | ||||||
Cost of revenue | 8.2 | 7.6 | ||||||
Cost of revenue—amortization of acquired technology | 2.6 | 3.6 | ||||||
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Total cost of revenue | 10.8 | 11.2 | ||||||
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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 | ||||||
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Total operating expenses | 57.6 | 61.9 | ||||||
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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 | ) | |||||
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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 | ||||||
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Net income | 18.2 | % | 12.9 | % | ||||
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The following discussion compares the six months ended June 30, 2011 with the six months ended June 30, 2010.
Nine Months Ended September 30, | ||||||||
2011 | 2010 | |||||||
Revenue: | ||||||||
OEM | 74.1 | % | 74.4 | % | ||||
Creative professional | 25.9 | 25.6 | ||||||
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Total revenue | 100.0 | 100.0 | ||||||
Cost of revenue | 8.2 | 7.2 | ||||||
Cost of revenue—amortization of acquired technology | 2.6 | 3.4 | ||||||
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Total cost of revenue | 10.8 | 10.6 | ||||||
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Gross profit | 89.2 | 89.4 | ||||||
Marketing and selling | 26.4 | 24.5 | ||||||
Research and development | 13.3 | 14.9 | ||||||
General and administrative | 13.8 | 15.8 | ||||||
Amortization of other intangible assets | 4.2 | 4.6 | ||||||
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Total operating expenses | 57.7 | 59.8 | ||||||
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Income from operations | 31.5 | 29.6 | ||||||
Interest expense, net | 2.6 | 4.4 | ||||||
Loss (gain) on foreign exchange | (0.3 | ) | 1.9 | |||||
(Gain) loss on derivatives | 0.5 | (0.2 | ) | |||||
Loss on extinguishment of debt | 0.5 | — | ||||||
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Total other expense | 3.3 | 6.1 | ||||||
Income before provision for income taxes | 28.2 | 23.5 | ||||||
Provision for income taxes | 9.6 | 7.7 | ||||||
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Net income | 18.6 | % | 15.8 | % | ||||
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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 | |||||||||
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Total revenue | $ | 60,795 | $ | 48,896 | $ | 11,899 | ||||||
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OEM Creative professional Total revenue Nine Months Ended
September 30, Increase 2011 2010 $ 67,830 $ 57,488 $ 10,342 23,660 19,766 3,894 $ 91,490 $ 77,254 $ 14,236
Revenue
Revenue was $60.8$91.5 million and $48.9$77.3 million for the sixnine months ended JuneSeptember 30, 2011 and 2010, respectively, an increase of $11.9$14.2 million, or 24.3%18.4%.
OEM revenue was $44.8$67.8 million and $36.0$57.5 million for the sixnine months ended JuneSeptember 30, 2011 and 2010, respectively, an increase of $8.8$10.3 million, or 24.4%18.0%, mainly due to ana $10.5 million increase in display imaging revenue. Display imaging and driver revenue increased $12.0 million in the nine months ended September 30, 2011, as compared to the same period in 2010 partially due to increased volume of unit shipments of products by our customers such as OEMs and independent software vendors, whothat embed our fonts and technology solutions.solutions such as independent software vendors, and increased royalties from customers in markets such as e-book readers, mobile phones, navigation devices and digital cameras. These increases were partially offset by decreases in printer imaging royalty revenue, which we believe is primarily attributable to the recent events in Japan.
Creative professional revenue increased $3.1was $23.7 million or 24.3%, to $16.0and $19.8 million for the sixnine months ended JuneSeptember 30, 2011 as compared to $12.9and 2010, respectively, an increase of $3.9 million, for the six months ended June 30, 2010.or 19.7%. Non-web revenue, which includes direct, indirect and custom revenue, increasedaccounted for the majority of the increase, was primarily a result of increased direct sales to our enterprise customers and custom revenue. Web revenue also increased mainly due to our newer products offerings, such as Web font services.
Cost of Revenue and Gross Profit
Cost of revenue, excluding amortization of acquired technology, was $5.0$7.5 million and $3.7$5.6 million for the sixnine months ended JuneSeptember 30, 2011 and 2010, respectively, an increase of $1.3$1.9 million, or 33.8%34.9%. As a percentage of total revenue, cost of revenue, excluding amortization was 8.2% and 7.6%7.2% in the sixnine months ended JuneSeptember 30, 2011 and 2010, respectively. The dollar 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 sixnine months ended JuneSeptember 30, 2011, as compared to the same period in 2010, a greater portion of our OEM revenue had higher associated costs. A portion of our OEM revenue in the first nine months of 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 nine months ended September 30, 2011, contributed to the increase in cost of revenue, as compared to the same period in 2010.
Amortization of acquired technology was $1.6$2.4 million and $1.7$2.6 million for the sixnine months ended JuneSeptember 30, 2011 and 2010, respectively, a decrease from 3.6% to 2.6% of revenue.respectively.
Gross profit was 89.2% in the sixnine months ended JuneSeptember 30, 2011, as compared to 88.8%89.4% in the sixnine months ended JuneSeptember 30, 2010, an increasea decrease of 0.4%,0.2 percentage points, 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 $3.9was $24.2 million or 31.6%, to $16.0and $18.9 million in the sixnine months ended JuneSeptember 30, 2011 as compared to $12.2and 2010, respectively, an increase of $5.3 million in the six months ended June 30, 2010.or 28.0%. Personnel expenses increased $2.1$3.0 million, partially due to higher variable compensation due to a higher sales volume and partially the result of an increase in headcount. Headcount increased 13.3%5.6% as a result of a few key new hires and from our recent acquisition of Ascender. Online advertising expense increased $0.7$0.9 million in the first half ofnine months ended September 30, 2011, as compared to the same period in 2010, partially due to targeted advertising for our new webWeb font services product and partially the result of our efforts to increase traffic to our websites. Increased discretionary spending on travel related expenses, tradeshows and outside services contributed $0.7$0.9 million to the overall increase in the sixnine months ended JuneSeptember 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 $0.5was $12.2 million and $11.5 million for the nine months ended September 30, 2011 and 2010, respectively, an increase of $0.7 million, or 6.2%, to $8.15.7%. Personnel and personnel related expenses increased $1.0 million in the sixnine months ended JuneSeptember 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 athe result of an increase in headcount. HeadcountResearch and development headcount increased 15.5%15.0% at JuneSeptember 30, 2011, as compared to JuneSeptember 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$0.6 million increase in reclassifications to cost of sales for service work on revenue recognized during the first halfnine months of the year.2011. Travel related expenses increased $0.2 million in the first half ofnine months ended September 30, 2011, as compared to the same period in 2010, the result of an increase in discretionary spending for attendance at tradeshows.2010.
General and Administrative.General and administrative expense was $8.3$12.6 million and $8.1$12.2 million in the sixnine months ended JuneSeptember 30, 2011 and 2010, respectively, an increase of $0.2$0.4 million or 3.0%,3.5%. Personnel expenses increased $0.1 million, mainly the result of an increase in professionaldue to higher salary expense. Professional service expenses, including tax related fees and personnel related expenses.legal, increased $0.3 million in the nine months ended September 30, 2011, as compared to the same period in 2010.
Amortization of Other Intangible Assets. Amortization of other intangible assets was $2.6$3.8 million and $2.4$3.6 million infor the six monthnine months ended JuneSeptember 30, 2011 and 2010, respectively, an increase of $0.2 million, mainly due toresulting from our acquisition of Ascender.Ascender in December 2010.
Interest Expense, Net
Interest expense, net of interest income, was $1.7$2.3 million and $3.4 million for the sixnine months ended JuneSeptember 30, 2011 as compared to $2.3 million for the six months ended June 30,and 2010, respectively, a decrease of $0.6$1.1 million, or 24.1%31.9%. The decrease isin interest expense was the result of lower total debt outstanding in the first half of 2011, as compared to the same period in 2010.and lower interest rates on our debt. Total debt outstanding, net of unamortized financing costs, and debt discounts, at JuneSeptember 30, 2011 was $57.3$45.9 million, as compared to $81.2$78.5 million at JuneSeptember 30, 2010. At September 30, 2011, the blended interest rate on our Credit Facility was 2.5%, as compared to a blended rate of 4.0% at September 30, 2010.
Loss (Gain) Loss on Foreign Exchange
(Gain) lossLoss (gain) on foreign exchange was a gain of $0.5$0.3 million and a loss of $2.7$1.5 million for the sixnine months ended JuneSeptember 30, 2011 and 2010, respectively, an increase of $3.2 million, primarily due toresulting from 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.
(Gain) Loss (Gain) on Derivatives
Loss (gain)(Gain) loss on derivatives was a loss of $1.0$0.5 million andfor the nine months ended September 30, 2011, as compared to a gain of $1.8$0.2 million for the sixnine months ended JuneSeptember 30, 2010, the net result of changes to the market value of our derivative contracts. In the nine months ended September 30, 2011, and 2010, respectively, a decrease of $2.8 million. In the first half of 2011, $0.9$0.4 million of the loss relatesrelated to our currency swap contract and the remaining $0.1 million relatesloss related to our interest rate swap contract. In the first half ofnine months ended September 30, 2010, we recorded a gainloss of $2.3$1.0 million on our currency swap contract and a lossgain of $0.5$0.8 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
ForOur effective tax rate was 34.1% and 32.8% for the sixnine months ended JuneSeptember 30, 2011 and 2010, our effective tax rate was 34.8% and 36.8%, respectively. During the first half ofnine months ended September 30, 2011, ourthe effective tax rate included a 0.9% benefit fromdecrease for 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 halfnine months of 2011, for share based compensation expense. During the nine months ended September 30, 2010, the effective tax rate included a 1.9% decrease due to the reversal of reserve for income taxes, as compared to a decrease of 0.1% in the same period in 2011. Our effective tax rate in the nine months ended September 30, 2010, included a benefit of 0.9% for the effect of rate changes on deferred taxes, which did not occur in the same period in 2011.
Liquidity and Capital Resources
Cash Flows for the SixNine Months Ended JuneSeptember 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 JuneSeptember 30, 2011, our principal sources of liquidity were cash and cash equivalents totaling $53.1$51.5 million and a $20.0$120.0 million revolving line-of-credit, of which $47.3 million was undrawn at Juneoutstanding as of September 30, 2011 and December 31, 2010, however, availability under the line-of-credit was reduced by approximately2011. Approximately $4.0 million at both June 30, 2011 and December 31, 2010of the revolving line of credit is unavailable as a result of our outstanding derivative instrumentsinstrument with our lender. In JuneDuring the third quarter of 2011, we made a voluntary prepayment of $5.0 million.refinanced our debt; further details are found in Note 8. 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, | Nine Months Ended September 30, | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Net cash provided by operating activities | $ | 17,469 | $ | 21,918 | $ | 28,237 | $ | 35,708 | ||||||||
Net cash used in investing activities | (791 | ) | (2,189 | ) | (1,681 | ) | (3,633 | ) | ||||||||
Net cash used in financing activities | (6,477 | ) | (9,712 | ) | (17,894 | ) | (12,320 | ) | ||||||||
Effect of exchange rates on cash and cash equivalents | 73 | 39 | 30 | 250 | ||||||||||||
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Total increase in cash and cash equivalents | $ | 10,274 | $ | 10,056 | ||||||||||||
Increase in cash and cash equivalents | $ | 8,692 | $ | 20,005 | ||||||||||||
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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$28.2 million in cash from operations during the sixnine months ended JuneSeptember 30, 2011. Net income, after adjusting for depreciation and amortization, amortization of deferred financing costs, loss on extinguishment of debt, 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 $30.0 million in cash. Deferred revenue generated $2.2 million in cash, mainly the result of the receipt of a large royalty pre-payment. Increases in accounts receivable and prepaid expenses and other assets, and decreases in accounts payable and accrued income taxes used $2.5 million in cash. Decreases in accrued expense and other liabilities used $1.4 million in cash, as a result of the payment of variable compensation accrued in previous periods.
We generated $35.7 million in cash from operations during the nine months ended September 30, 2010. 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$25.1 million in cash. Deferred revenue
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$5.0 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 andaccrued income taxes provided $3.0 million in cash. The $2.7 million increase in accrued expenses and other liabilities provided $2.7was mainly due to an increase in variable compensation in the current year. Due to the timing of vendor payments, accounts payable used $0.1 million in cash.
Investing Activities
InDuring the sixnine months ended JuneSeptember 30, 2011, we used $1.7 million in cash used infor investing activities, which consisted mostly of purchases of property and equipment. InDuring the six month periodnine months ended JuneSeptember 30, 2010, we used $3.6 million in cash used infor investing activities, which consisted of purchasesthe purchase of an exclusive license and the purchasepurchases of property and equipment.
Financing Activities
Cash used in financing activities for the sixnine months ended JuneSeptember 30, 2011 was $6.5$17.9 million. Payments on long-term debt used $8.9$76.8 million in cash, offset by $1.5proceeds from the issuance of debt, net of issuance costs of $56.1 million as a result of the refinancing of our debt in July 2011, see Note 8. Other financing activities during the nine months ended September 30, 2011 included $1.8 million in cash received from stock option exercises and $0.9$1.0 million related to the excess tax benefit on stock options. Cash used in financing activities for the nine months ended September 30, 2010 was $12.3 million. Payments on long-term debt used $13.4 million in cash, partially offset by $0.6 million in cash received from stock option exercises and $0.5 million related to the excess tax benefit on stock options for the sixnine 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 JuneSeptember 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,Modifications2011 and Extinguishments of Debt, these fees will be accounted for as deferred financing costs and will be amortizedwas scheduled 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 inexpire on July 30, 2012.
Borrowings under 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 paymentbear interest 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%1.25%, as defined in the credit agreement, or (ii) LIBOR plus a 3.75%, payable monthly.2.25%. The Company is required to pay an unused line 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. As of JuneSeptember 30, 2011, the blended interest rate on the
Amended and Restated Credit AgreementFacility was 3.95%2.5%. There are no required repayments. The Company, in accordance with the Credit Facility, is permitted to request that the Lenders, at their election, increase the secured credit facility to a maximum of $140.0 million. In addition, the Amended and Restated Credit Agreement providedFacility provides 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. Additional limits are imposed on acquisition related expenses. We also must maintain a minimum fixed charge ratio. As of JuneSeptember 30, 2011, the maximum leverage ratio permitted was 2.75:3.00:1.00 and our leverage ratio was 1.07:0.86:1.00 and the minimum fixed charge coverage ratio was 1.25:1.00 and our fixed charge ratio was 2.54:1.00. We were alsoFailure 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’s and its subsidiaries’ ability to incur debt or liens and engage in compliancesale-leaseback transactions, make loans and investments, incur additional indebtedness, engage in mergers, acquisitions and asset sales, transact with affiliates and alter its business.
In connection with the minimum liquidity requirement,refinancing, the Company incurred closing fees of $0.8 million plus legal fees of approximately $0.4 million. In accordance with Available Cash,ASC Subtopic No. 470-50,Modifications and Extinguishments of Debt, these fees were accounted for as defineddeferred 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 AmendedCredit Facility was written off as a debt extinguishment and Restated Credit Agreement,charged to other expense in the third quarter of $63.4 million. The Amended and Restated Credit Agreement also contained a no material adverse change clause.2011.
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, | Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||||||||||||||||
2011 | 2010 | 2011 | 2010 | 2011 | 2010 | 2011 | 2010 | |||||||||||||||||||||||||
Net income | $ | 5,598 | $ | 3,044 | $ | 11,038 | $ | 6,306 | $ | 5,992 | $ | 5,923 | $ | 17,030 | $ | 12,229 | ||||||||||||||||
Provision for income taxes | 2,971 | 1,788 | 5,893 | 3,665 | 2,920 | 2,304 | 8,813 | 5,969 | ||||||||||||||||||||||||
Interest expense, net | 860 | 1,108 | 1,739 | 2,290 | 558 | 1,084 | 2,297 | 3,374 | ||||||||||||||||||||||||
Depreciation and amortization | 2,363 | 2,305 | 4,667 | 4,648 | 2,320 | 2,318 | 6,987 | 6,966 | ||||||||||||||||||||||||
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EBITDA | $ | 11,792 | $ | 8,245 | $ | 23,337 | $ | 16,909 | $ | 11,790 | $ | 11,629 | $ | 35,127 | $ | 28,538 | ||||||||||||||||
Share based compensation | 1,753 | 1,474 | 3,322 | 2,811 | 1,806 | 1,395 | 5,128 | 4,206 | ||||||||||||||||||||||||
Non-cash add backs | 42 | 447 | 73 | 552 | 64 | 248 | 137 | 800 | ||||||||||||||||||||||||
Restructuring, issuance and cash non-operating costs(2) | 116 | 35 | 228 | 347 | 445 | (2 | ) | 673 | 345 | |||||||||||||||||||||||
Acquisition expenses | — | — | 94 | — | — | — | 94 | — | ||||||||||||||||||||||||
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Adjusted EBITDA(1) | $ | 13,703 | $ | 10,201 | $ | 27,054 | $ | 20,619 | $ | 14,105 | $ | 13,270 | $ | 41,159 | $ | 33,889 | ||||||||||||||||
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(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. |
(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 AgreementFacility also containedcontains 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 AgreementFacility as of JuneSeptember 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
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, | Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||||||||||||||||
2011 | 2010 | 2011 | 2010 | 2011 | 2010 | 2011 | 2010 | |||||||||||||||||||||||||
Income from operations | $ | 9,695 | $ | 6,624 | $ | 19,212 | $ | 13,176 | $ | 9,573 | $ | 9,706 | $ | 28,785 | $ | 22,882 | ||||||||||||||||
Depreciation and amortization | 2,363 | 2,305 | 4,667 | 4,648 | 2,320 | 2,318 | 6,987 | 6,966 | ||||||||||||||||||||||||
Share based compensation | 1,753 | 1,474 | 3,322 | 2,811 | 1,806 | 1,395 | 5,128 | 4,206 | ||||||||||||||||||||||||
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Net adjusted EBITDA (1) | $ | 13,811 | $ | 10,403 | $ | 27,201 | $ | 20,635 | $ | 13,699 | $ | 13,419 | $ | 40,900 | $ | 34,054 | ||||||||||||||||
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(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 FASBFinancial 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
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.overnight repurchase agreements. Deposits of cash held outside the United States totaled approximately $1.8$4.0 million and $2.2 million at JuneSeptember 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 JuneSeptember 30, 2011, two customers individuallyone customer balance accounted for 17.3% and 12.2%, respectively,15% 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 JuneSeptember 30, 2011 and 2010, noone customer accounted for 10% of our total revenue. No one customer accounted for more than 10% of our revenue.revenue for the three months ended September 30, 2011 or for the nine months ended September 30, 2011 and 2010, respectively.
Derivative Financial InstrumentsInstrument 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,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 beare 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 Credit Facility and previously, the Amended and Restated Credit Agreement, fluctuatesboth fluctuate with either the prime rate or the LIBOR interest rate. At JuneSeptember 30, 2011, the blended rate of interest on our outstanding debt was 3.95%2.5%. For each one percent increase in interest rates our interest expense would increase by $0.6$0.5 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 thisthese financial instrumentinstruments at JuneSeptember 30, 2011, and December 31, 2010, was a liability of approximately $0.5$0.4 million and $0.6 million, respectively. In the three months ended JuneSeptember 30, 2010, we recognized a loss of $0.4 million. In the nine months ended September 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$0.8 million, respectively. The losses have been included in (gain) loss (gain) on derivatives in theour 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
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 JuneSeptember 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 JuneSeptember 30, 2011, the note balance was approximately $8.7$6.7 million. The effect of an immediate 10% strengthening of the U.S. dollar as compared to the Euro would result in a $0.9$0.7 million unrealized transaction loss on this note receivable which would be reported in loss (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. The total fair value of the currency swap instrument at September 30, 2011 and December 31, 2010 was $0.9 million and $1.5 million, respectively. For the three months ended JuneSeptember 30, 2011 and 2010, we incurred a gain of $0.5 million and a loss of $1.2 million, respectively, on the currency swap contract. For the nine months ended September 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$1.0 million, respectively, on the currency swap contract. The gainslosses and lossesgain on the currency swap are included in (gain) loss (gain) on derivatives in the accompanying condensed consolidated statements of income.
Losses(Gains) and (gains)losses on the intercompany note are included in loss (gain) loss on foreign exchange in the accompanying condensed statements of income, and were a net gainloss of $0.2$0.6 million and a net lossgains of $1.4$1.3 million for the three months ended JuneSeptember 30, 20102011 and 2009,2010, respectively. In the sixnine months ended JuneSeptember 30, 2011 and 2010, we incurred a net gain of $0.8$0.2 million and a net loss of $2.4$1.0 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 JuneSeptember 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 Securities and Exchange Act of 1934, as amended, or 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 JuneSeptember 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 JuneSeptember 30, 2011 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
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 JuneSeptember 30, 2011 and 2010, approximately 55.2%51.9% and 63.6%63.2%, respectively, of our total revenue was derived from operations outside the U.SU.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
(a) | Unregistered Sales of Equity Securities |
None.
(b) Use of proceeds
(b) | Use of proceeds |
Not applicable.
(c) | Purchases of Equity Securities by the Issuer and Affiliated Purchasers |
The following table provides information about purchases by the Company during the quarter ended September 30, 2011 of equity securities that are registered by the Company pursuant to Section 12 of the Exchange Act:
(c)Monotype Imaging Holdings Inc. 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.
Period | Total Number of Shares Purchased | Average Price Paid per Share | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs | Maximum Number (or Approximate Dollar Value) of Shares that May Yet be Purchased Under the Plans or Programs | ||||||||||||
July 1, 2011 to July 31, 2011 | — | $ | — | — | — | |||||||||||
August 1, 2011 to August 31, 2011(1) | 344 | 0.00 | — | — | ||||||||||||
September 1, 2011 to September 30, 2011 | — | — | — | — | ||||||||||||
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Total | 344 | $ | 0.00 | — | — | |||||||||||
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(1) | The Company repurchased unvested restricted stock in accordance with the 2007 Stock Option and Incentive Plan. The price paid by the Company was determined pursuant to the terms of the 2007 Stock Option and Incentive Plan and related restricted stock agreement. |
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.
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: | By: | / | ||||||
Douglas J. Shaw | ||||||||
President, Chief Executive Officer and Director
| ||||||||
(Principal Executive Officer) | ||||||||
Date: November 1, 2011 | By: | /s/ SCOTT E. LANDERS | ||||||
Scott E. Landers | ||||||||
Senior Vice President, Chief Financial Officer, Treasurer and Assistant Secretary (Principal Financial Officer) |
Listed and indexed below are all exhibits filed as part of this report.
Exhibit | Description | |
10.1 | ||
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. | ||
General Continuing Guaranty by and among the Guarantors (as defined therein) and Wells Fargo Capital Finance, LLC, dated as of July 13, 2011. | ||
Security Agreement by and among the Grantors (as defined therein) and Wells Fargo Capital Finance, LLC, dated as of July 13, 2011. | ||
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 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. |
*** | Furnished herewith. |
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