Edited Transcript of TYPE earnings conference call or presentation 26-Apr-19 12:30pm GMT

Q1 financial results fell short of our expectations. We remain confident that we can achieve our full year guidance and believe our sales pipeline and go-to-market approach provide the runway to execute over the remainder of the year.

Before we go further, I would like to address the shortfall relative to our Q1 revenue expectations. Today, our growth is primarily driven by delivering creative value to the enterprise customer. Our enterprise deals are typically recurring and can be significant in size with customers deploying across multiple-use cases which can create variability in closed cycles. This quarter, several expected deals moved into future periods. As a reminder, beginning in Q3 of last year, we began to work with our existing customers to migrate them to our Mosaic platform and we are seeing a strong uptake across our installed base. Mosaic, which provides significant value from both the workflow and creative perspective, requires us to introduce a new contract into the renewal cycle adding time to typical close periods.

The added time is well spent as there is considerable long-term benefit to our customers and higher lifetime value to Monotype. As a company, we let these deals follow a natural course rather than ask our customers to manage duplicate renewal processes. While not as significant, in 2018, we saw similar delays in Q3 and then a solid overperformance in Q4. As we look forward, we feel the pipeline and the competitive standing of our offering provides more than sufficient opportunities, and we will be focused on go-to-market execution to close the gap.

Now turning to our financial performance. Q1 revenue was $51.4 million, a 9% decrease year-over-year. Non-GAAP net adjusted EBITDA increased slightly largely due to the cost alignment we completed in 2018.

Now turning to our business highlights. We believe that our long-term strategy is sound and that our enterprise plan is working. We made good progress on several fronts this quarter reinforcing the strategy we’ve employed and the value customers derive from our offering.

Starting with Creative Professional. Revenue was down 6% to $32.8 million primarily due to Digital Commerce and Olapic. Enterprise revenue was flat. From an enterprise perspective, we saw a continued strong demand for our Mosaic offering across our current customer base. During the quarter, we added a significant new feature by enabling the addition of third-party fonts to further improve the design workflow for enterprises and agencies. Customers can now upload licensed non-Monotype fonts within the platform, creating a more flexible and enterprise-ready way to discover, design and deploy projects across their creative networks.

Our type design expertise continues to be a critical element of our value creation. A few weeks ago, we released one of the most significant new typefaces in recent history, Helvetica Now. Helvetica Now is a family of fonts that have been carefully and respectfully redrawn by the Monotype studio for the modern era. Perhaps the world’s most popular and well-known typeface, the Helvetica family has been used in millions of designs by countless brands and creative professionals. Every character within Helvetica Now has been redrawn, and a host of useful alternates have been added to help brands meet modern-day digital branding challenges. Early industry and customer feedback has been very positive. We look forward to seeing the impact Helvetica Now has on the creative community and our business. As we look to the remainder of the year, from an enterprise perspective, the underlying strategies for continued growth from leveraging the expertise of our type designers to increasing our footprint with Mosaic and continued reinforcement from our strong renewal space are all contributing to our confidence as we move forward.

Now turning to Digital Commerce. While our business declined in the quarter, this channel continues to be important for leveraging multiple sales efforts. As we discussed last quarter, we continue to identify brand customers who initially connect with us on our Digital Commerce platform and then transition them to our enterprise sales team where we can determine and meet the full scope of their needs. In Q1, many leads that started on our Digital Commerce platform evolved into more significant enterprise transactions. With respect to the stand-alone performance of our Digital Commerce channel, we continue to work on site enhancements, inventory expansion and search engine optimization as catalyst to return this portion of our business to modest growth. We do believe the combination of these efforts as well as the optimization of our partner reach is the right formula to meet our long-term business goals.

Now turning to our Olapic offering. We are very pleased with our new business and upsell progress in the quarter. New business signed in the quarter more than tripled sequentially and including upsell was double the amount we signed during the height of the 2018 privacy disruption. We were excited to be selected by Walmart to participate in its Connected Content Partner Program. This partnership will allow us to help brands that sell their products on walmart.com. Olapic can activate a brand’s user-generated and influence their content directly from our platform to their walmart.com product pages. Extending a brand’s visual content to Walmart’s massive e-commerce audience at point of purchase gives brands an additional way to drive value from their Olapic relationship and provide their customers with more engaging and relevant content.

Now turning to OEM. OEM declined 14% to $18.6 million, which was greater than expected largely due to the way printer market declines are impacting parts of our customer base. As we noted on the last call, some customers are weathering the downward pressure better than others. In some cases, customers have extended our IP deployment across printer and non-printer devices, while others continue to face significant cost pressures which can impact our overall customer relationship. In total, about 85% of our estimated 2019 printer revenue remains under fixed contracts. Net-net, the negative impact on the quarter was approximately $1 million relative to our initial expectation.

We made good progress in other areas of OEM in Q1, signing several new automotive deals in Japan. That, combined with the progress we made in Q4 in both Korea and China, positioned us well for increased revenue in future years. As we’ve discussed before, automotive deals tend to have a longer sales cycle. However, once these relationships are established, they tend to generate significant recurring revenues for multiple years. Overall, OEM continues to be an important part of our business and we look forward to extending the value we provide in returning to modest growth over the long term.

Now I would like to share some high-level thoughts on the remainder of 2019. We are reiterating the guidance given on our last call. As I said at the outset, we believe that our customer value proposition remains strong, and the addition of Mosaic has provided another opportunity to deepen our customer relationships. As we serve the enterprise at greater scale, we are seeing more significant deals enter our pipeline, similar to the large deal we saw in Q4. We have good visibility into these deals on an annual basis, but given their size and complexity, we typically do not include them in quarterly guidance. With that said, from a 2019 guidance perspective, we expect to improve sequential revenues and profitability in Q2 and a significant step up in performance in the second half of the year. This is consistent with the seasonality over the last 3 years which coincides with the emergence of Creative Professional as the primary growth driver in the business.

And now I’ll turn the call over to Tony. Tony?

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Anthony Callini, Monotype Imaging Holdings Inc. – CFO, Executive VP, Treasurer & Assistant Secretary [4]

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Thanks, Scott. While we would have preferred a faster start to 2019, we are reaffirming full year revenue and EBITDA guidance and increasing earnings per share guidance. As always, we remain focused on sustainable growth and expanding EBITDA margins. Although first quarter revenue was off 9% from the prior year, our non-GAAP net adjusted EBITDA grew slightly as operating costs continue to decline underscoring our continued laser focus on expanding profitability margins. And while we’re seeing more variability in the revenue line from quarter-to-quarter, we remain on track to achieve full year top line expectations.

Now turning to the results. Q1 revenue of $51.4 million decreased 9% year-over-year. Non-GAAP net adjusted EBITDA of $11 million increased slightly as compared to the first quarter last year. As a percentage of revenue, however, we gained 220 basis points as EBITDA was 21.5% of revenue this quarter as compared to 19.3% of revenue last year. Q1 Creative Professional revenue of $32.8 million decreased 6% with enterprise revenues coming in approximately flat year-over-year and Digital Commerce and Olapic declining.

First quarter OEM revenue of $18.6 million declined by 14% primarily due to trends in the printer space that Scott outlined earlier as well as lower embedded revenue as compared to the prior year. Q1 gross profit margin was 79.6%, reflecting a less favorable product mix. Operating expenses of $37.4 million or $8.8 million were 19% lower than the prior year reflecting the impact of prior efficiency programs, certain nonrecurring costs last year and a sustained focus on optimizing operating costs. Excluding nonrecurring costs, operating expenses decreased $5.8 million or 13% over the past year.

First quarter GAAP net income was $2.7 million as compared to a loss of $1.2 million in Q1 of last year. Net income per diluted share was $0.06 as compared to a net loss of $0.03 last Q1. Non-GAAP earnings per diluted share was $0.19 compared to $0.22 last year. Our effective tax rate for the quarter was a benefit of 6%. Our rate this quarter was materially and positively impacted by the completion of an IRS audit in Q1, which allowed us to reverse certain tax reserves on our books. For the full year, we now anticipate a reduction in our effective rate to 17% to 19%.

Turning to the balance sheet. Cash and cash equivalents at the end of Q1 were $46.4 million, a decrease of $13.7 million from the end of 2018, largely reflecting the more than $11.4 million return to shareholders through our dividend and share repurchase programs partially offset by cash generated from operations. This quarter, we generated $4.1 million of cash from operations as compared to $7.5 million in the prior year primarily due to working capital changes from the timing of certain payments and customer collections. We expect working capital to have a positive impact in Q2 as compared to the use of cash in Q1. Q1 non-operating uses of cash includes $5.2 million of debt repayments and $4.8 million for our quarterly dividend. In Q1 of this year, we repurchased approximately 371,000 shares for a total consideration of $6.6 million. Additionally, during the first quarter, we replaced our existing $150 million revolving line of credit with a new 5-year $200 million line at terms that we believe are generally more favorable than those in our prior line of credit. At the end of Q1, we had $70 million outstanding under the new line.

Now turning to our guidance. As I mentioned earlier, for the full year 2019, we are reaffirming our revenue guidance of $247 million to $257 million, non-GAAP net adjusted EBITDA guidance of $71.5 million to $78.5 million and operating expense guidance of $158 million to $161 million. We are updating our expectations for non-GAAP diluted EPS to be between $1.29 to $1.43, up from $1.18 to $1.30 and GAAP diluted EPS to be between $0.81 and $0.95, up from the $0.72 to $0.84 we had guided to earlier. The improvement and expected EPS estimates reflect a reduction in our full year effective tax rate to 17% to 19% as a result of the recently completed IRS tax audit.

For the second quarter of 2019, we expect revenue of $54.5 million to $59.5 million, gross profit margins between 80% and 82% and operating expenses between $36.5 million and $38.5 million. We anticipate non-GAAP net adjusted EBITDA to be between $13.8 million and $17.3 million, non-GAAP diluted EPS to be between $0.23 and $0.31 and GAAP diluted EPS to be between $0.11 and $0.19.

As Scott mentioned, the business has evolved. Seasonal variability of our results have increased, and our guidance implies a material step-up in financial performance in the second half of the year. The pipeline within the enterprise business is strong and building and includes deals of a larger size than average as compared to what we saw in Q4 of last year. But we don’t typically include deals of this magnitude in quarterly guidance. We factor their impact into full year expectations.

Our longer-term financial expectations remain consistent with revenue growth between 3% and 7% and non-GAAP net adjusted EBITDA margins between 32% and 36%. Over time, we continue to expect the decline in printer to average out to about a 5% compound growth rate. However, we now expect a decline in printer revenue to be more front loaded with an approximate $2 million negative impact this year relative to our initial 2019 guidance. We expect the decline to level off as we enter 2021 and stabilize at about the same level we projected earlier.

In closing, while we are disappointed with the slower start to 2019, we are encouraged by the underlying fundamentals of our business, especially in the enterprise space. We will remain focused on managing the business closely on both the top and bottom line. As always, we’ll focus on execution as profitability outpaces revenue growth to create enhanced long-term shareholder value.

And now I’ll turn the call over to the operator to begin the Q&A. Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question comes from Jackson Ader from JPMorgan.

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Jackson Edmund Ader, JP Morgan Chase & Co, Research Division – Analyst [2]

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Great. First one, let’s just hit the Creative Professional deal slippage just right off the top. So can we get a little bit more color as to why, I guess, they didn’t actually get signed in the quarter? Was there any kind of competitive pressure? Do you feel like it was all internal, customers just sitting on their hands? What’s the main driver there?

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Scott E. Landers, Monotype Imaging Holdings Inc. – CEO, President & Director [3]

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Yes. Jackson, it’s Scott. We would absolutely characterize it as internal or more administrative in nature. There has been no change in the competitive environment. Just to give you a couple data points. The push deals probably totaled about $3 million. As of the date of this call, about $2 million of them have been closed. Another data point for you, we mentioned our enterprise business was flat in the first quarter. Our Q2 and guidance implies enterprise growth rates in excess of 20% which would put us back for that first half of the year average, which is where we would expect the business to be for the full year. So we are seeing it follow through.

Just some color on how these deals work. As you know, we’ve got a really great installed base with many, many customers who use our IP. And in many cases, there’s an opportunity for us to license them across more use cases. So an example may be a customer comes up for renewal. Through the renewal conversation, we find out that they’ve actually deployed our IP perhaps into 2 more use cases, maybe it’s into something like digital ads or apps. And we will then go and resize that renewal, basically upsell it to a larger amount. So there’s a few different things that can happen on the customer side.

First, they need to go and determine which budget this will come out of. In some cases, it can be — they can have a corporate-level font budget, which makes it easier. In other cases, they may have to go department by department and get budget allocations.

The other thing that we’re doing is upon each one of these renewals, we’re talking to our customers about getting on to the Mosaic platform, which is something that’s really exciting for us because in addition to deploying our IP and giving them a piece of paper with a license, we can now give them an amazing platform that helps them work with that IP and helps them be much more efficient and provides a heck of a lot more creativity. So we’re also introducing the Mosaic contract, and many, many customers are taking us up on that. That does introduce a brand new contract into the system. So where perhaps legal would not have to be involved because we may have been working with this customer for 3, 4, 5 years. Now since it’s a new piece of paper, it’s an additional review in addition to any budget upsell we may have.

And so the last thing I’ll say in these prepared remarks, we’re in this for the long game. We do not overly pressure our customers to try and run dual renewal processes. Like, “Hey, get us the renewal paperwork and then go and redo all the paperwork for the upsell, and we’ll get that done next quarter.” We try and do this all at once, and then sometimes it may push something 2, 4, 6 weeks on us.

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Anthony Callini, Monotype Imaging Holdings Inc. – CFO, Executive VP, Treasurer & Assistant Secretary [4]

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Yes. Jackson, this is Tony. I mean I think another thing we highlighted is we’re just seeing more seasonality and more variability between quarters. And if you look at the Q4 that we had where everything came in, everything signed and we saw a little bit of this pressure in Q1 and Q3 of last year. And I think it’s similar to the nature of having these larger enterprise deals that come right down to the end of the quarter. And like Scott says, we’re not really in the business of pressuring our customers into doing deals that don’t make sense for either of us. So we’re in this for the long game, but we’re just seeing a little more seasonality now.

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Jackson Edmund Ader, JP Morgan Chase & Co, Research Division – Analyst [5]

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Okay. All right. That makes sense. Scott, you mentioned just a minute ago about a customer will and their use cases within the enterprise. So can you give us a sense as to how far along you are where maybe you’ve identified some large customers that are using Monotype’s IP across use cases that maybe they aren’t fully paying for? And how much of an opportunity that, that still remain?

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Scott E. Landers, Monotype Imaging Holdings Inc. – CEO, President & Director [6]

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Yes. We think we’ve got a fair amount of runway left there from that perspective, Jackson. If you went back a couple of years ago, I think we weren’t very penetrated at all, right? It was more proactive when customers were coming to us knowingly. Over the last few years, we’ve done a really great job educating our customers, being able to have that fulsome conversation with them. But I’d say, if our market share is working with the top 45% of brands, we’re maybe about halfway there. It’s hard to get it down to an exact science, but I think we still have a lot of runway left where there’s a fair amount of customers who may be paying us no dollars or small dollars. And in reality, each one of those customers could be 6 figures accounts for us.

And as you know, we have an active program to help identify who those customers are. We’ve trained our sales team to when we approach these customers. We’re not holding them hostage. We’re making them aware and trying to leverage that into a bigger conversation on and perhaps other things they may not have considered without having us at the table, so plenty of runway to go.

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Operator [7]

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And our next question comes from Zach Cummins from B. Riley FBR.

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Zachary Cummins, B. Riley FBR, Inc., Research Division – Analyst [8]

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I guess can you just go more — I know you’ve talked a lot around kind of the increased seasonality in the business. But I mean can you just talk more about your confidence in getting to your full year guide still? I mean it’s — are we having to assume that you’re needing to close one of those deals similar to the outsized deal that you closed in Q4? Just kind of some of the puts and takes and how you’re thinking out it as we go into the really ramped-up second half of the year.

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Scott E. Landers, Monotype Imaging Holdings Inc. – CEO, President & Director [9]

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Yes. I mean we won’t go into the specifics of customer-by-customer analysis, Zach. I mean what I can say is that confidence comes from the size of the pipeline. That confidence comes from looking at the size of, I’ll say, normal large deals that we have. And in the last call, they asked about competition rate and our competitive standing and what we’re seeing in close rates and what we’re seeing in renewal rates. As it comes to the large opportunities, our ear isn’t hanging on every single one of them happening. But based on that visibility, I think if we look at the portfolio of those deals that are out there and the likelihood that we can be successful, I think it makes us feel good overall for the year.

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Zachary Cummins, B. Riley FBR, Inc., Research Division – Analyst [10]

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Understood. And then in terms of Olapic, it sounds like they had a little bit of better performance here in terms of bookings in the quarter. Can you talk a little bit more about the Walmart connected partner program and what sort of opportunity that means for Olapic going forward?

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Scott E. Landers, Monotype Imaging Holdings Inc. – CEO, President & Director [11]

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Yes, sure. And I absolutely would characterize this quarter with Olapic where there was many signs of that business turning and moving in the right direction with real data from customers. So that feels good to us. As it relates to the Walmart partnership, that could be a great opportunity for us to provide more value for our customers. And before we get into what that value could be, I would say we’re really proud of our team for putting us in the position to be selected so quickly, right? I think when they looked at the value that our platform has for our customers, when we look jointly at the customers who sell on walmart.com and those that were customers of ours, there was an awful lot of overlap. So it kind of fast-tracked this relationship from both sides.

So as we look at a partnership like that, you can imagine all the different companies that may sell on walmart.com. And if you go and look at the product pages, they probably have kind of old school imagery, right? Not the same imagery that they may be using on their own e-commerce sites or that they may be using in advertising because a lot of them are customers from ours, and we know that a lot of them are harnessing the power of this user-generated content or influencer content because it’s just so much more engaging. What this partnership enables us to do is for those customers that are on the Olapic platform, walmart.com can be an additional channel. And now we can light up their product pages on walmart.com with the same content that we may be using on their own e-commerce channels. For us, that creates an incremental revenue opportunity for each one of our customers. Should they choose to do that, that would be considered a new channel.

The other thing it provides is for all those customers that are selling at Walmart that aren’t current customers of Olapic, that creates another ingress point to where we can go and acquire new customers. So this is brand new for us. I can tell you that the piping and the technology is built and ready to go. And I can tell you that the interest that we’re seeing from customers as far as pipeline build is really good. So we’re really happy about 2 things: what this says about our capability and probably secondly, what this says about the market we bought into. Even though we had all of these issues and stumbles around the privacy disruption, there has been no stopping the thesis here that brands need more content, engaging content in order to maximize their engagement with today’s consumer.

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Anthony Callini, Monotype Imaging Holdings Inc. – CFO, Executive VP, Treasurer & Assistant Secretary [12]

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Yes. That’s what we’ve been hearing from our customers all along in a number of case studies. So having something like this where it’s effectively being validated by Walmart in terms of how critical user-generated content is to them, feels good. And actually, as we look at the Olapic business, I think there’s a lot to feel really positive about.

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Operator [13]

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(Operator Instructions) There are no further questions at this time. I will now like to turn the call back to Scott Landers, CEO, for any further remarks.

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Scott E. Landers, Monotype Imaging Holdings Inc. – CEO, President & Director [14]

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Very well. Thanks for joining us today. We appreciate your support over the last few years, and we appreciate your continued support as we continue to work hard for you here in 2019. Thanks, everybody.

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Operator [15]

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Ladies and gentlemen, thank you for your participation in today’s conference. This concludes today’s program. You may all disconnect. Everyone, have a great day.