MONOTYPE IMAGING HOLDING 10-K 2018
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
For the fiscal year ended December 31, 2017
For the transition period from to
Commission File Number 001-33612
MONOTYPE IMAGING HOLDINGS INC.
(Exact name of registrant as specified in its charter)
Registrants telephone number, including area code: (781) 970-6000
Securities Registered Pursuant to Section 12(b) of the Act:
Securities Registered Pursuant to Section 12(g) of the Act:
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☑ No ☐
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes ☐ No ☑
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 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 ☑ 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 ☑ No ☐
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of large accelerated filer, accelerated filer, smaller reporting company and emerging growth company in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer ☑ Accelerated filer ☐ Non-accelerated filer ☐ Smaller reporting company ☐
Emerging growth company ☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No ☑
The aggregate market value of the registrants common stock held by non-affiliates of the registrant, computed by reference to the last reported sale price of the common stock as reported on the NASDAQ Global Select Market on June 30, 2017 was approximately $578,250,116 (assumes officers, directors, and all shareholders beneficially owning 10% or more of the outstanding common shares are affiliates).
The number of shares outstanding of the registrants common stock as of February 20, 2018 was approximately 41,560,522.
DOCUMENTS INCORPORATED BY REFERENCE.
Portions of the registrants definitive Proxy Statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A in connection with the 2018 Annual Meeting of Stockholders are incorporated herein by reference into Part III of this report.
MONOTYPE IMAGING HOLDINGS INC.
TABLE OF CONTENTS
As used in this report, the terms we, us, our, Monotype and the Company mean Monotype Imaging Holdings Inc. and its subsidiaries, unless the context indicates another meaning.
Unless otherwise noted, all dollar amounts in this report are expressed in United States dollars.
We own, have rights to, or have applied for the trademarks and trade names that we use in conjunction with our business, including our name and logo. All other trademarks and trade names appearing in this report are the property of their respective holders.
Certain statements in this Annual Report on Form 10-K are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the Securities Act), and Section 21E of the Securities Exchange Act of 1934, as amended (the Exchange Act). These statements involve a number of risks, uncertainties and other factors that could cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by these forward-looking statements. Factors which could materially affect such forward-looking statements can be found in the section entitled Risk Factors in Part 1, Item 1A in this Annual Report on Form 10-K. Investors are urged to consider these factors carefully in evaluating the forward-looking statements and are cautioned not to place undue reliance on such forward-looking statements. The forward-looking statements made herein are only made as of the date hereof and we will undertake no obligation to publicly update such forward-looking statements to reflect subsequent events or circumstances.
We are a leading global provider of design assets, technology and expertise that are designed to enable the best user experiences, ensure brand integrity and help companies engage their best customers. Monotype empowers expression and engagement for creatives, designers, engineers and marketers at the worlds most revered brands. These professionals sit at globally recognized organizations or are independent creatives who support these organizations. We support their efforts by producing compelling content that builds beloved and valued brands, providing technology that cultivates meaningful engagement with their brand enthusiasts, and providing intelligence and insight through the measurement of content performance.
At the highest level, we organize our business operations into two areas:
Creative ProfessionalsOur focus is to help companies provide high-quality, branded or personalized content across multiple devices and mediums. Our solutions, which include type, branded mobile content, visual content marketing solutions, custom design services, and technologies that facilitate engagement with a companys best customers, are licensed through our direct sales channel, e-commerce and partner platforms. We work with a wide range of customers worldwide, including brands, agencies and publishers.
OEMOur focus is to provide consumer device manufacturers and independent software vendors, or ISVs, with the right solutions for delivering consistent, compelling user experiences. Our solutions power the visual expression of the leading makers of a wide range of devices, including laser printers, digital copiers, automotive displays, mobile phones, navigation devices, e-book readers, tablets, digital cameras, digital televisions, set-top boxes, consumer appliances and Internet of Things devices, as well as provide a high-quality text experience in numerous software applications and operating systems.
Our principal office is located in Woburn, Massachusetts, with regional offices in San Francisco, Los Altos and Los Angeles, California; Boulder, Colorado; Elk Grove Village and Chicago, Illinois; New York, New York; Cordoba, Argentina; Salfords and London, United Kingdom; Bad Homburg and Berlin, Germany; Noida, India; Shanghai and Hong Kong, China; Seoul, Republic of Korea; and Tokyo, Japan.
Industry Overview and Market Opportunity
As global communication and commerce continue to advance, individuals now have greater access to information than ever before. As a result, digital and especially, mobile digital continues to be the dominant source for media consumption. This has created a digitally tethered consumer, emboldened to direct what information they see and how they receive it. The resulting shift in the consumers balance of power has dramatically altered traditional marketing paradigms for marketers and advertisers.
This digital transformation introduced a glut of new distribution channels by which marketers reach their intended audiences. This, coupled with increased complexity around media consumption due to a proliferation of devices, screens and operating platforms, has put pressure on organizations to modernize their technology and increase the level of digital expertise across the entire organization. Business strategies and capabilities designed by business leaders and creative professionals at organizations today now require a digitally-oriented-first approach.
Todays creative professionalsincluding brand managers, agencies and other marketing professionals are challenged with a complex blend of offline and online communication channels, a myriad of platforms available for consuming content, and a change in consumer preference for more personalized messaging that has made designing and managing a global brand highly complex. Creative professionals require an abundance of content, delivered seamlessly across online and offline platforms, that is engaging, on brand, and relevant to its intended audience. For device manufacturers, the challenge is ensuring both the brand assets and design deploy everywhere with the look-and-feel the author intended.
Our customers turn to us for design assets, technology and expertise, which address the needs of an ever-changing landscape, whether they are content creators, the marketers distributing the content, or the consumer device manufacturers and independent software vendors and developers who enable the consumption of content. These customers use our products to enhance user experiences, create compelling digital and print content, and provide platforms for using content to engage their best customers as brand advocates.
Content creators include brands, advertising agencies, graphic designers, printers, publishers, and non-professional creators of content (such as social media users, designers, bloggers and self-publishers). Content creators produce digital and/or printed material, and they seek creative ways to convey meaning and differentiate identity. Fonts are an important tool for this differentiation. For example, creative professionals at multinational corporations are increasingly tasked with creating solutions that extend their brand into new markets. The challenge is to ensure that branding efforts are reflected consistently in every communication, regardless of media. In addition, creative professionals need design tools that integrate seamlessly into their workflows, making them more efficient. Web fonts, which travel with the content to a users connected device for consistent viewing regardless of the environment, are an example of a solution that addresses the needs of creative professional customers. Social media and messaging platforms offer a wide range of opportunities for consumers (non-professional creatives) to express a personal brand. Stickers, emojis and fonts allow consumers to communicate who they are in fun and expressive ways and, when their use is monitored and reported, also provide analytics back to the brand.
Marketers are facing new challenges. Traditional media channels for reaching consumers, such as broadcast television, are losing their audience. A proliferation of digital media channels for consuming content has forced marketers to reshape their strategies to better serve a mobile-first, multi-screen marketing landscape. The content is on-demand and has a heavy social component through which consumers interact with the content and other consumers. Marketers need to have compelling content in order to participate in these channels without being viewed as intrusive or inauthentic. Two positive aspects of the changing landscape are that consumers are actively seeking to align with brands they view as reflecting their values and that these media platforms (including social and messaging platforms) offer more direct data on their users and their interaction with the content. Marketers now have an opportunity to make their best customers advocates of the brand. The content that these users create (broadly defined in the industry as user-generated content or UGC) allows consumers to provide an authentic voice for promoting brands, since the brand earns it through customer loyalty rather than paying for it. Similarly, marketers have the opportunity to provide branded content to these customers who want to show their support. With the right technology platforms, marketers can measure these interactions and refine their programs to optimize the return on their marketing expenses.
Consumer Device Manufacturers
Consumer devices are platforms for consuming content. These devices require robust multimedia functionality, as consumers create and share videos, animations and other rich-media and interactive content across various mobile devices. Consumer device manufacturers must display multimedia content, including text, from these different sources, while providing a consistent look-and-feel across devices, supporting worldwide languages and, in many cases, supporting enhanced personalization. As technologies enable media to move seamlessly from one device to another, scalable, multilingual type and related display solutions that are optimized for these devices are critical. For example:
The market for laser printers and digital copiers is more mature than the rest of the consumer device market. As a result, the least expensive end of the market has become more commoditized. Laser printer manufacturers are responding by increasing the functionality of their products with advances such as a larger number of embedded fonts, enhanced control panel functionality, and creating new printing paradigms and services offerings, including mobile printing and managed print services. Comprehensive global text solutions and related technologies continue to be an important part of printing platforms.
Independent Software Vendors and Developers
Similar to consumer devices, software solutions and cloud services are marketed globally. For example, ISVs require multilingual text solutions for product user interfaces as well as a range of type to add functionality to applications. Mobile device game developers want a distinctive and consistent typeface for their games, especially when the game is designed to run on multiple devices and consoles. In addition, developers want to customize their offerings with fonts specific to their vertical market or geographic regions.
ISVs and platform developers are increasingly distributing their solutions through software-as-a-service, cloud-based models and to multiple devices including PCs, mobile phones, game consoles, tablets and other devices. As a result, developers require font technologies that allow products to maintain a consistent, high-quality user experience regardless of the delivery model and device and its screen resolution.
Monotypes product offering, primarily delivered through a term-based license or a software-as-a-service (SaaS) subscription, allows content creators and marketers to produce beautiful, authentic and impactful brands on any screen, in print or across the web.
Design Assets and Related Technology Solutions
Type at the Forefront
Screen Imaging Technologies
Printer Imaging Technologies
Design Assets for Brand and Self-Expression
Marketing Solutions for Brand Engagement
Global Brand Engagement and Social Endorsement through Mobile and Digital Channels
Design and Technology Expertise to Support Global Brand Initiatives
Design Assets. Our design assets serve varying needs within diverse organizations. Our rich, multi-language font IP and embedded font technology are crucial to our OEM customers who manufacture high-volume consumer devices that require superior multilingual legibility in support of multimedia functionality and multinational distribution. That same font IP is used to build a brands identity (at a corporate or product level). Our Monotype Libraries, comprised of the Monotype, Linotype, ITC, Ascender, FontFont and Bitstream type collections, are some of the worlds best known inventories of type. Our selection is continuously expanding, adding even more fonts from some of the worlds best type designers. Today, we offer more than 139,000 typeface designs, featuring a rich blend of timeless classics and cutting-edge designs, which support more than 250 Latin and non-Latin languages. Our UGC technology enables brands to extract highly authentic content in the form of photos and videos from users on social media platforms at scale. This content can be used in marketing programs to better connect with intended audiences and improve marketing outcomes. Our mobile messaging IP and technology is vital to those marketers looking to cultivate meaningful engagement with brand enthusiasts across the worlds leading messaging platforms.
Expertise, Experienced Leadership and Employee Base. Our expertise in software engineering and font design gives us a strong foundation to meet the challenges of todays consumer environments. We are home to some of the worlds top type designers who provide expert consultation and custom design services to help customers articulate their distinctive brand values. We have deep domain expertise and engineering skills in mobile messaging and visual content marketing through our acquisitions of Swyft Media and Olapic. Our experts work closely with customers to achieve goals like developing successful, engaging brands. Our employee base includes some of the worlds most experienced professionals who intimately understand typefaces and software.
Established Relationships with Market Leaders. Several of our customer relationships date back 25 years or more. Our OEM customers are many of the largest and most successful companies in each of the markets they serve. In the consumer device space, we provide solutions to market leaders like Google, Apple and Microsoft. In the laser printer market, our customers include eight of the top ten laser printer manufacturers based on the volume of units shipped worldwide. Our Creative Professional customers include major international retail, consumer packaged goods, financial services, media, publishing and marketing solutions companies, such as Hearst Magazines and Pearson, as well as major design firms.
Global and Multi-Channel Presence. Our customers are located throughout the world. In 2017, 2016 and 2015, 56.9%, 58.3% and 45.5% of our revenue, respectively, was derived from sales by our customers located in the United Kingdom, Germany, China and Japan. With our enterprise sales associates covering North America, EMEA, and APAC coupled with our
websites, including myfonts.com, fonts.com, fontshop.com and linotype.com, we provide a footprint and sales channel designed to fit any customers needs. We support all of the worlds major languages and have specifically designed our solutions for displaying rich content in Asian and other non-Latin languages. We enable OEM customers to engineer a common platform supporting multiple languages, reducing costs and time to market, and increasing product flexibility. China, Japan and Korea are increasingly becoming centers of design, manufacturing and consumers of consumer devices, and we have more than 25 years of experience partnering with leading Asian companies such as Ricoh, Toshiba and Kyocera Mita.
Attractive Business Model. We have a significant, predictable base of licensing revenue that is based, in part, on multi-year financial commitments by our customers, mainly due to our established relationships with OEMs, the high volume of web transactions and growing recurring direct business. Other revenue contracts have renewable term licenses, and in Creative Professional, our Olapic offering is a subscription-based model, providing a recurring stream of revenue. The high volume of low-dollar web transactions runs at a predictable rate, which together lends to an overall recurring and predictable revenue base of over approximately 85% of our total revenue.
Technological and Intellectual Property Leadership. Our technologies are key to providing unique, flexible and comprehensive solutions for content creation, distribution and consumption, and we continue to invest in extending our technology and market leadership positions. For example, the flexibility of our offerings enables us to provide tailored, comprehensive solutions for specific industries, such as the automotive industry. In addition, our Olapic technology platform for gathering, moderating, distributing and measuring user-generated content and other types of branded content, when combined with our traditional offerings, provides our customers a unique solution for designing content and using that content for marketing purposes.
Monotype empowers expression and engagement for creatives, designers, marketers and engineers who have two primary intentions:
Our strategy is to make these design and marketing activities more effective and efficient for our customers. For those designing content or user experiences, our strategy begins with our rich heritage of the worlds most iconic typefaces, which form the foundation of the best designs. We also provide complimentary design elements and content, including user-generated content, as well as services for creating branded emojis, to major global brands and individual designers who seek innovative ways to express a brand message. In addition, we offer technology that allows efficient discovery, curation and publishing of this content.
For marketers who seek to use this content to communicate with their best customers, our strategy is to enable distribution of branded user experiences to attract, acquire and engage their customers. The goal is to provide earned contentcontent that is generated and shared by brand enthusiaststhat resonates with these customers through an authentic representation of the brand. The best of these customers become advocates and promoters for the brand with their own voice (and content). These interactions are intended to drive further customer action such as a revenue transaction or brand evangelism. Marketers cultivate a meaningful relationship with brand enthusiasts to generate earned, authentic
content while the measurement of earned content helps marketers improve ecommerce merchandising, increase performance by optimizing creative decisions, and connect and reward their most valuable followers.
From creating compelling brand experiences to cultivating engaging relationships between brands and their best customers, we strive to be the first place to turn for the design assets, technology and expertise that empower brand engagement and the best user experiences. Following are the key components of our strategy:
Empower the Creative Process. Our focus is to help designers and other creative professionals succeed as workflows and publishing environments become more complex. Our customers are creating content that is distributed through a broad range of publishing environments, including the web, mobile devices, applications, as well as print. We provide a comprehensive selection of typeface designs, custom typefaces, worldwide language support and fonts that are tuned to display in the highest quality, regardless of the output medium. Our licensing options provide flexible coverage to meet our customers evolving requirements. A key component of our strategy is offering simplified, flexible subscriptions to large portions of our font library with the goal of making it easier for creative professionals to access and use any font.
Our customers creative needs are not limited to fonts. Just as distribution environments have grown in complexity, so too have the forms of content to which consumers respond. Consumers find content that they view as authentic (as opposed to staged) as more attractive. To that end, our strategy includes offering design assets and other types of content that meet this requirement. User-generated photos and videos, which reflect consumers interpretation of the brand, and branded assets such as emoji, which allow consumers to express themselves using a brands imagery, are examples of how Monotype is expanding its offering to meet these broader creative requirements.
Cultivate Meaningful Digital Engagement. Our strategy now extends beyond the creation of content to marketers use of this content to communicate with their best customers. Monotype enables distribution of branded user experiences to attract, acquire and engage our customers consumers. The goal is to provide content that resonates with these consumers through an authentic representation of the brand. With the acquisition of Olapic, we offer a platform for gathering and moderating user-generated content. The platform allows brands to make user-generated content actionable and then to measure response rates to determine what designs are most effective, which contributors offer the best content and what programs are most successful.
In addition, mobile messaging apps, photo sharing apps and other social platforms have become the backbone for communicating in todays world, especially among younger consumers. In these environments, consumers are eager to personalize their text messages and their posts with branded content such as digital stickers and emojis. Our Mobile Engagement Platform provides value to stakeholders across the mobile messaging ecosystem and provides access to many of the top messaging applications platforms through partnerships, including with Apples iMessage and Google. Brands and advertisers are able to reach consumers through branded, monetizable content that is integrated within the social experience. In addition, consumers are able to take advantage of shareable, branded content such as digital stickers and emojis to express themselves.
Increase Penetration of our Technologies and Fonts into a Wide Range of Device Categories. Our technologies and fonts play an important role in the mass-market success of device categories such as automotive displays, smart TVs, wearables, mobile devices and e-book readers and tablets. We have an established base of customers in these categories, and we will seek to expand within existing accounts as new models are added, or as new product lines are introduced. We intend to continue to pursue new design wins such as next-generation in-vehicle displays, helping customers to meet key requirements including brand integrity, high legibility and worldwide language support. We also seek to expand our value proposition to device manufacturers by providing a more holistic solution that serves both product experience and branding needs. Our offering is an important component of the user experience on consumer devices. Yet the user experience is only one manifestation of a manufacturers brand communication. As an example, a mobile smartphone manufacturer utilizes our font IP and embedded technology to optimize the user experience of the device. That same manufacturer uses our font IP, messaging IP, and UGC technology to develop a brands identity and influence purchase decisions of its target audience in leading channels. Our strategy includes introducing a licensing model that meets not only the device-side needs of device engineers but also the design and marketing needs of creative professionals within these large organizations.
Leverage Our Long-Term Relationships. We constantly strive to strengthen our long-term relationships by working closely with OEMs to fulfill evolving requirements, such as providing value-added solutions that differentiate offerings, reduce cost, or capitalize on new technology paradigms. For example, we offer printer manufacturers flexible, high-performance printer driver tool kits that support popular operating systems. OEMs are able to integrate and customize robust printing capabilities to gain a competitive edge. Our flexible architecture, support for multiple print languages and extensive use of common code enables printer manufacturers to speed products to market while reducing development time and costs. Using our solution to support multiple page description languages, in combination with our fonts and drivers, provides a more complete offering. In addition, we offer licensing models that make deploying our fonts and technologies broadly within a printer manufacturers offering easy for the long term.
Independent Software Vendors and Developers
Expand Support of ISVs to All Deployment Environments. Our core offering to ISVs and developers consists of providing fonts, custom typefaces and rendering technologies for language coverage, platform compatibility, user experience enhancement and creative expression. Options for accessing and deploying our software and applications have expanded from on-device to secure cloud-based services and combinations of the two. New environments such as AR/VR require our customers to display content in ways not envisioned previously. Our AR/VR solution enables ISVs to create a robust text experience within these applications. Our ISV strategy is to license our fonts and tools to provide the flexibility ISVs need to create compelling offerings for devices like tablets, smartphones and medical devices.
Overall, We Seek to:
Expand and Deepen our Global Presence. We intend to drive our revenue growth by leveraging our knowledge of global markets and through our global operations. Our strategy
focuses on countries and regions where our target Creative Professional and OEM customers and prospects are concentrated. Our approach includes expanding our presence in key countries and developing a direct or indirect presence in countries that we evaluate as having strong potential for growth. Through this organic expansion and possible acquisitions, we intend to increase our ability to service consumer device manufacturers and creative professionals throughout the world.
Selectively Pursue Complementary Acquisitions, Strategic Partnerships and Third-Party Intellectual Property. We intend to continue to selectively pursue acquisitions, strategic partnerships and third-party intellectual property to accelerate our time to market with complementary solutions, penetrate new geographies and enhance our intellectual property portfolio. We believe that the market for our solutions is still fragmented. We have a demonstrated track record of identifying, acquiring and integrating companies that enhance our intellectual property portfolio. Our acquisition on August 9, 2016 of Olapic, Inc., a privately-held earned content platform company, has diversified and expanded our offering. In addition, in 2017 we created a strategic partnerships team to focus on integrating our design assets and technologies into larger platforms that our customers use for design and marketing tasks. This team also seeks to expand distribution of our offering through third-party marketplaces and ecommerce sites.
We are committed to serving the design and marketing needs of our customers. Our technologies and services are sold to customers in two principal markets: Creative Professional and OEM. In 2017, 2016 and 2015 our revenue in these two markets was as follows (in thousands):
Our solutions are embedded in a broad range of consumer devices and are compatible with most major operating environments. We partner with operating system and software application vendors such as Google, Apple, Microsoft, Oracle and Access. Additionally, we are an active participant in the development of industry standards which pave the way for support of advanced typographic capabilities across multiple devices. We are active in the development of various technology standards, including the ISO/IEC core font technology standardization work through our participation in the ISO MPEG Committee; various projects coordinated by W3C that include Web Fonts Working Group, CSS Working Group and Publishing Working Group; and Interactive Advertising Bureau as an active participant in multiple IAB Working Groups contributing to the development of various standards and industry guidelines. We serve as a chair of the W3C Web Fonts Working Group demonstrating our commitment to ensuring that web clients and applications effectively support fonts and font technologies, ultimately bringing to web developers and end users the highest level of text quality, performance and flexibility. In the past, we also contributed to a wide variety of standardization activities including the developments of hardware-accelerated vector graphics APIs (The Khronos Group), Java ME platforms for mobile devices (Java Community
Project), DVB Multimedia Home Platform, and IDPF EPUB e-book standards and OMA Rich Media Environment.
Our customers are among the worlds leading consumer device manufacturers and most well-known brands, including:
In 2017, 2016 and 2015, our top ten licensees by revenue accounted for approximately 27.3%, 30.3% and 33.5% of our total revenue, respectively. For the years ended December 31, 2017, 2016 and 2015, no customer individually accounted for more than 10% of our total revenue. For the quarters ended December 31, 2017, 2016 and 2015, no customer individually accounted for more than 10% of our total revenue.
Marketing and Selling
Our sales representatives directly target prospective clients with design, marketing and engineering requirements, focusing primarily on establishing long-term relationships. In addition, our renewals team maintains on-going relationships with existing customers and focuses on renewing specific contracts and engagements with those customers. Our e-commerce websites, myfonts.com, fonts.com, fontshop.com and linotype.com drive sales from professional and casual users.
Our marketing organization works to deliver a consistent message detailing our capabilities and to develop new avenues for presenting our solutions. We promote our solutions through a combination of web content, social media outlets, public relations activities, opt-in e-mail newsletters, blogs, editorial articles, brochures, print advertising, case studies, collateral, speaking engagements, special events, exhibitions, educational programs, and attendance and participation at industry conferences and trade shows. We promote our e-commerce websites, myfonts.com, fonts.com, fontshop.com and linotype.com through a combination of affiliate programs, search engine optimization and e-mail marketing.
Research and Development
We have a strong commitment to research and development for core technology programs directed at creating new products, product enhancements and new applications for existing products, as well as funding research into future market opportunities. Each of the markets we serve is generally characterized by rapid technological change and product innovation. We believe that continued timely development of new products and product enhancements to serve existing and new markets is necessary to remain competitive. Further, we continue to advance our machine learning capabilities across the business. At Olapic, we leverage machine learning to streamline moderation of user-generated content for our clients by processing over 180 million images in 2017, training the Olapic platform to sort through images that are unfit for use. In type, we use machine learning to improve search and discovery of font IP for our customers that access our libraries via our ecommerce sites and applications. This aids the users in finding the right IP for their specific needs quickly and more accurately. Our research and development operations are located in Woburn, Massachusetts; Los Altos, California; Boulder, Colorado; Elk Grove, Illinois; New York, New York; Cordoba, Argentina; Salfords, United Kingdom; Bad Homburg and Berlin, Germany; Noida, India; Hong Kong, China; and Tokyo, Japan.
In 2017, 2016 and 2015, we incurred research and development expenses of $37.7 million, or 16.1% of sales, $28.9 million, or 14.2% of sales and $21.5 million, or 11.2% of sales, respectively. Further information on research and development expenses may be found in Item 7, Managements Discussion and Analysis of Financial Condition and Results of Operations.
We rely on a combination of copyright, patent and trademark laws and on contractual restrictions to establish and protect proprietary rights in our technologies and fonts. Whenever possible, we enter into non-disclosure agreements with our suppliers, partners and others to limit access to and disclosure of our proprietary information.
We apply for U.S. and international patents with respect to our technologies, and seek copyright registration of our software and U.S. and international trademark registration in those instances which we determine are competitively advantageous and cost effective to do so. We have been granted a total of 21 patents and have 24 patents pending with the U.S. Patent and Trademark Office with many also filed in foreign jurisdictions. Some of our most important patents are related to our dynamic subsetting, font compression and machine learning technologies. We have unregistered trademarks and, where appropriate, registered trademarks on the key fonts in our Monotype Libraries. We intend to continue our policy of taking all measures we deem necessary to protect our patent, copyright, trade secret and trademark rights.
Some of our fonts are owned by third parties that we license under exclusive or non-exclusive agreements. We have also collaborated with third parties in the production and development of fonts.
Our solutions compete with those offered by a variety of companies, including vendors of print and screen imaging technologies, printer drivers and design tools, as well as designers and distributors of fonts. We compete principally on the basis of our technical innovation,
engineering and customer support expertise, the breadth of our font offerings and the overall performance of our solutions, including reliability and timely delivery. Competition with our solutions comes from a variety of sources, including companies that license technologies and fonts, such as Adobe, and local providers of solutions that are specific to a particular countrys language requirements, such as Morisawa in Japan. We also compete with open source fonts and technologies, including the FreeType text renderer, a product of an open source collaborative organization that provides its Linux font rendering code for free, and Google, which provides open source fonts. In addition, we compete with several small players in the emergent components of the content marketing space in which we participate, such as, but not limited to, Bazaarvoice, Curalate and Adobe Experience Manager Livefyre. The competition for our custom font design services generally comes from companies offering their own type libraries and custom type services, including boutique font foundries and independent professionals.
Employees and Consultants
At December 31, 2017, we employed 734 persons. The table below provides our employees by functional area.
None of our employees or consultants is represented by a union or covered by a collective bargaining agreement. Our German employees are represented by works councils in Berlin and Bad Homburg. These works councils have the right to participate in certain decisions by Monotype GmbH, including operational changes, such as relocation of the business or change of control transactions, and social matters such as wages and salaries and working hours. We believe that our relations with our employees and consultants are good.
Information concerning revenue from our two principal markets for the last three years may be found in Note 14 to our consolidated financial statements included in this Annual Report on Form 10-K. We do not allocate expenses and assets to our two principal markets, Creative Professional and OEM, and operating results are assessed on an aggregate basis to make decisions about the allocation of resources. Further information about our principal markets and segment information, including geographic revenue, may be found in Note 14 to our consolidated financial statements included in this Annual Report on Form 10-K.
Corporate and Investor Information
We maintain a website at monotype.com. We make available on our website documents describing our corporate governance and our Code of Business Conduct and Ethics. We are not including the information contained on our website as a part of, or incorporating it by reference into, this Annual Report on Form 10-K. We make available free of charge through our website our proxy statements, registration statements, annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, and amendments to these
reports, as soon as reasonably practicable after we electronically file such material with, or furnish such material to, the Securities and Exchange Commission, or the SEC. Our SEC filings are also available over the Internet at the SECs website at http://www.sec.gov. You may also read and copy any document we have filed by visiting the SECs public reference room at 100 F Street, NE., Washington, DC 20549. Please call the SEC at 1-800-SEC-0330 for further information about the public reference room. The SEC maintains an internet site that contains reports, proxy and information statements and other information regarding our filings at www.sec.gov. Our SEC reports and other information may also be inspected at the offices of the Financial Industry Regulatory Authority, 1735 K Street, N.W., Washington, D.C. 20006.
Set forth below are certain risk factors that could harm our business, results of operations and financial condition. You should carefully read the following risk factors, together with the financial statements, related notes and other information contained in this Annual Report on Form 10-K. This Annual Report on Form 10-K contains forward-looking statements that contain risks and uncertainties. Please refer to the discussion of Forward-Looking Statements on page two of this Annual Report on Form 10-K in connection with your consideration of the risk factors and other important factors that may affect future results described below.
Risks Related to Our Industries
Business and licensing models are evolving and if we are not able to successfully make our design and marketing solutions available under these models, our business prospects could suffer.
New licensing and business models are evolving in the industries that we serve. For example, as channels of distribution for content and the devices used to consume content increase and diversify, the need for flexible license models to address the needs of designers, marketers, and engineers across these platforms increases. As licensing models evolve, we may not be successful in adapting to or maintaining these new business models and our business prospects could suffer.
These new licensing and business models include subscription-based licensing and service agreements for specified time periods in addition to perpetual license fees. Although our subscription models are designed to increase the number of customers who purchase our products and services and create a recurring revenue stream that is more predictable, these models create certain risks related to the timing of revenue recognition and potential reductions in cash flows. This may give rise to a number of risks, including:
We face significant competition in various markets, and if we are unable to compete successfully, our ability to generate revenue from our business could suffer.
We face significant competition in the market for the design assets, including type, and technologies that we offer. We believe that our most significant competitive threat comes from companies that provide design assets and marketing technologies to large global organizations, including Adobe and Google. We also compete, with respect to specific offerings such as type, with the internal resources of our customers to whom we license our solutions. Similarly, we also face competition from providers of free technology, such as FreeType, and from font foundries (especially those whose products are specific to a particular countrys language), font-related websites, providers of branded digital content, and independent professionals.
Some of our current or future competitors may have significantly greater financial, technical, marketing and other resources than we do, may enjoy greater name recognition than we do or may have more experience or advantages than we have in the markets in which they compete. These advantages may include, among others:
Many of our Creative Professional and OEM customers also rely on design and marketing solutions, including fonts and technologies, provided by our competitors. As a result, we must continue to invest significant resources in product development in order to enhance our solutions and introduce new high-quality solutions to meet the wide variety of competitive pressures. Our ability to generate revenue from our business could suffer if we fail to do so successfully.
Current and future industry standards may limit our business opportunities.
Various industry leaders have adopted or are in the process of adopting standards for consumer devices that incorporate, or have the potential to incorporate, our technologies. In addition, standards applicable to web-based development and distribution, such as web publishing platforms, are evolving. Although we have made some efforts, where applicable, to have our solutions adopted as industry standards, these efforts have been limited, and we do not control the ultimate decision with respect to whether our solutions will be adopted as industry standards in the future or, to the extent they are adopted, whether and for how long they will continue as such. If industry standards adopted exclude our solutions or we are unable to be compatible with such adopted solutions, we will lose market share and our ability to secure the business of customers subject to those standards will be adversely affected. Costs or potential delays in the development of our solutions to comply with such standards could significantly increase our expenses and place us at a competitive disadvantage compared to others who comply faster or in a more cost efficient way or those whose solutions are adopted as the industry standard. We may also need to acquire or license additional intellectual property rights from third parties for standards compliance, which may not be available on commercially reasonable terms. We may be required to license our intellectual property to third parties for purposes of standards compliance.
Certain product solutions in our business are dependent on the ways that industry leaders conduct business, and these industry leaders may change the way that they interact with brands or with consumers in a manner that restricts us from providing products or services that reach these consumers.
Certain product solutions in our business are reliant on access to large industry leading social media and messaging platforms in order to provide value to our customers. If these platforms change the way they conduct business with their customers, limit functionality or discontinue third-party access to their networks, this could limit our ability to adequately perform our obligations. For example, Olapic relies on user generated content platforms like Instagram to source imagery for curation. Should access to those pictures be restricted for any reason, we might not be able to fulfill our commitment to deliver the curated content.
Open source or no-cost products and services may make us more vulnerable to competition because new market entrants and existing competitors could introduce similar products quickly and cheaply.
Open source refers to the free sharing of software code used to build applications in the software development community. Individual programmers may modify and create derivative works and distribute them at no cost to the end-user. To the extent that open source software that has the same or similar functionality as our technologies, or supports the offering of products or services that are competitive with ours, is developed or gains market share, demand for our technologies may decline; we may have to reduce the prices we charge for our technologies; and our results of operations may be negatively affected. For example, as the Android operating system became more prevalent in smart phones and tablets, the opportunity to embed our technology directly into these devices declined.
In addition, open source type software has become more widely available, including from competitors such as Google, and to the extent such type is widely adopted, the demand for our type offerings may decrease and our revenue could be adversely affected. Finally, our brand engagement product offerings compete with free products, some of which allow consumers to create their own content that may incorporate branded images. To the extent
that such free products are widely adopted, the demand for our brand engagement product offerings may decrease and our revenue could be adversely affected.
As we license our design assets and technologies into new markets, some of which are just developing, we could be subject to an increased number of legal claims.
As we market and supply our products and services to new industries, such as the automotive or medical device industries, we could be subject to product liability claims by such customers or users of our customers products. In addition, we may become involved in the recall of a product that is alleged or deemed to be defective due to or in connection with our fonts or font technologies. The successful assertion of a product liability claim or the expenses of a recall and the damage to our reputation could have an adverse effect on our business, results of operations or financial condition. In addition, our Swyft business relies on emojis and other digital assets that may sometimes resemble a specific person and our Olapic business relies on technology and services to help our customers source user generated content that reflects their brands. While we provide our customers with the tools to seek the rights to use the user generated content, in the event those rights are not obtained, we could be involved in claims relating to the misappropriation of a third partys intellectual property or a violation of a persons right of privacy. Such claims may subject us to public criticism, lawsuits, and/or reputational harm, all of which could disrupt our business and expose us to increased liability and adversely affect the demand for our products and services.
Risks Related to Our Design Assets, Technology and Expertise
If we fail to develop and deliver innovative products and services in response to changes in our industry, including changes in consumer tastes or trends, our revenue could decline.
The markets for our design assets, technology and expertise are characterized by rapid change and technological evolution and are intensely competitive and price sensitive. Our future success depends, to a great extent, on our ability to develop and deliver innovative products and services that are widely adopted in response to changes in our industry, that are compatible with the solutions introduced by other participants in our industry and for which our customers are willing to pay competitive prices. For example, as screen resolution technology improves, our offering must evolve to reflect the fact that text legibility is, in part, being addressed by these technical solutions. We rely on the introduction of new or expanded solutions with additional or enhanced features and functionality that reach across our customers brand engagement efforts to allow us to maintain our value in the face of downward pressure on our pricing resulting from efforts by our Creative Professional and OEM customers to reduce costs. We may not correctly identify new or changing market trends at an early enough stage to capitalize on market opportunities. For example, our customers are participating in an increasingly global marketplace, and we need to ensure our global product and services offerings meet these needs. Our failure to deliver such innovative solutions that allow us to stay competitive and for which we can maintain our pricing would adversely affect our revenue.
The success of our business is influenced by the ability of our products and services to allow our customers to express their brand across a variety of consumer devices, software applications and operating systems and content creation and distribution platforms.
To be successful we must design our products and services to allow our customers to engage with consumers across a variety of consumer devices, software applications,
operating systems and content creation and distribution platforms. We depend on the cooperation of consumer device manufacturers with respect to the components integrated into their devices, such as PDLs, as well as software developers that create the operating systems and applications, to incorporate our solutions into their product offerings. Content creation platforms are evolving rapidly and our solutions must meet the needs of both authors and device manufacturers who seek to have targeted customers consume information on multiple devices and across multiple channels. To the extent our products and services are less relevant, are incompatible, or contain errors or defects, our business would be adversely affected.
Our products and services compete with solutions offered by some of our customers, which have significant competitive advantages.
We face competitive risks in situations where our customers are also current or potential competitors. For example, Adobe is a significant licensee of our fonts, but Adobe is also a competitor with respect to enabling its customers to create consistent and accessible content. To the extent that Adobe or our other customers choose to utilize competing solutions they have developed or in which they have an interest, rather than utilizing our solutions, our business and operating results could be adversely affected. Adobe also offers broader product lines than we do, including software products that provide Adobe with greater opportunities to bundle and cross-sell products to its large user base. To the extent our customers were to offer products or services comparable to ours at a similar or lower price, our revenue could decline and our business would be harmed.
Our business is dependent in part on assets and rights that we license from third parties and these license rights may be inadequate for our business.
Certain of our solutions are dependent in part on the licensing and incorporation of technologies from third parties. We also license a substantial number of fonts from third-party designers and most of our sticker and emoji content from third party branded IP holders. For example, we have license agreements with Microsoft, Adobe and others under which we license certain fonts, and our e-commerce sites, including myfonts.com, rely upon the license of type from third parties. Our license agreements with these parties are limited by the ownership or licensing rights of our licensors. Our Olapic business also relies on user generated content owned by third parties for which our brand customers can seek usage rights.
If any of the technologies we source from third parties fail to perform as expected, if our licensors do not continue to support any of their technology or intellectual property, including fonts, because they go out of business or otherwise, or if the content is subject to infringement claims, then we may incur substantial costs in replacing the content or fall behind in our development schedule and our business plan while we search for a replacement. In addition, replacement content may not be available for license on commercially reasonable terms, or at all, which could subject us to claims by our customers for breach of the terms of our agreements with them.
Our business and prospects depend on the strength of our brands, and if we do not maintain and strengthen our brands, we may be unable to maintain or expand our business.
Maintaining and strengthening the brand of the Monotype Libraries and our other brands is critical to maintaining and expanding our business, as well as to our ability to enter into new markets for our products and services. If we fail to promote and maintain these brands
successfully, our ability to sustain and expand our business and enter into new markets will suffer. Maintaining and strengthening our brands will depend heavily on our ability to continue to develop and provide innovative and high-quality solutions for our customers, as well as to continue to maintain our strong online presence and relationships with third-party type and technology providers. For example, we will need to ensure our brand asset services are relevant for the evolving digital publishing needs of our Creative Professional customers. If we fail to adapt to changing consumer preferences or if we introduce solutions that our customers or potential customers reject, the strength of our brands could be adversely affected. Further, unauthorized third parties may use our brands in ways that may dilute or undermine their strength.
If we fail to adequately protect our intellectual property, we could lose our intellectual property rights, which could negatively affect our revenue or dilute or undermine the strength of our brands.
Our success is heavily dependent upon our ability to protect our intellectual property which includes our type and technologies. To protect our intellectual property, we rely on a combination of U.S. and international patents, design registrations, copyrights, trademarks, trade secret restrictions, end user license agreements, or EULAs, and the implementation and enforcement of nondisclosure and other contractual restrictions. Despite these efforts, we may be unable to effectively protect our proprietary rights and the enforcement of our proprietary rights may be extremely costly. For example, our ability to enforce intellectual property rights in the actual design of our fonts is limited.
We hold patents related to certain of our rasterizer and compression technologies and registered trademarks on many of our fonts. Our patents may be challenged or invalidated, patents may not issue from any of our pending applications or claims allowed from existing or pending patents may not be of sufficient scope or strength (or may not issue in the countries where products incorporating our technology may be sold) to provide meaningful protection or be of any commercial advantage to us. Some of our patents have been and/or may be licensed or cross-licensed to our competitors. We rely on trademark protection for the names of our fonts. Unauthorized parties may attempt to copy or otherwise obtain and distribute our proprietary technologies and fonts. Also, many applications do not need to identify our fonts by name, such as those designs embedded in mobile telephones and set-top boxes, and therefore may not need to license trademarked fonts. We sometimes protect fonts by copyright registration but we do not always own the copyrights in fonts licensed from third parties. In addition, we cannot be certain that we will be able to enforce our copyrights against a third party who independently develops fonts even if it generates font designs substantially similar or identical to ours.
For example, if we enter into a license agreement with a customer that permits the embedding of our fonts into an electronic document only for the purpose of viewing and printing the document, technologies, including those related to web-based fonts, may exist or may develop which allow unauthorized persons who receive such an embedded document to use the embedded font for editing the document or even to install the font into an operating system, the same as if the font had been properly licensed. Unauthorized use of our intellectual property or copying of our fonts may dilute or undermine the strength of our brands. Also, we may be unable to generate revenue from products that incorporate our type or technologies without our authorization. Monitoring unauthorized use of our solutions is difficult and expensive. A substantial portion of the consumer devices that require type or related technologies are manufactured in China. We cannot be certain that the steps we take to prevent unauthorized use of our intellectual property will be effective, particularly in
countries like China where the laws may not protect proprietary rights as fully as in the United States.
We may be forced to litigate to defend our intellectual property rights or to defend against claims by third parties against us relating to intellectual property rights.
Disputes and litigation regarding the ownership of technologies and fonts and rights associated with solutions such as ours are common, and sometimes involve patent holding companies or other adverse patent owners who have no relevant product revenue and against whom our own patents may therefore provide little or no deterrence. Third parties have from time to time claimed, and in the future may claim, that our products and services infringe or violate their intellectual property rights. Any such claims could cause us to incur significant expenses and, if successfully asserted against us, could require that we pay substantial damages and prevent us from selling our products. We may be forced to litigate to enforce or defend our intellectual property rights, to protect our trade secrets or to determine the validity and scope of other parties proprietary rights. Even if we were to prevail, any litigation regarding intellectual property could be costly and time-consuming and divert the attention of our management and key personnel from our business operations. We may also be obligated to indemnify our customers or business partners, including brand owners, pursuant to any such litigation, which could further exhaust our resources. Furthermore, as a result of an intellectual property challenge, we may be required to enter into royalty, license or other agreements, and we may not be able to obtain such agreements at all or on terms acceptable to us. We have been in the past involved in litigation with third parties, including Adobe, to defend our intellectual property rights and have not always prevailed. Finally, any such claims may subject us to public criticism, lawsuits, and/or reputational harm, all of which could disrupt our business and expose us to increased liability and adversely affect the demand for our products and services.
Certain component technologies in our solutions may be subject to open source licenses, which may restrict how we use or distribute our technologies or require that we release the source code of certain technologies subject to those licenses.
Certain open source licenses, such as the GNU Lesser General Public License, require that source code subject to the license be released or made available to the public. Such open source licenses typically mandate that proprietary technologies, when combined in specific ways with open source software, become subject to the open source license. We take steps to ensure that our proprietary technologies are not combined with, or do not incorporate, open source software in ways that would require our proprietary technologies to be subject to an open source license. However, few courts have interpreted the open source licenses, and the manner in which these licenses may be interpreted and enforced is therefore subject to uncertainty. While our EULAs prohibit the use of our technologies in any way that would cause them to become subject to an open source license, our customers could, in violation of our EULA, combine our technologies with technologies covered by an open source license.
In addition, we rely on multiple software engineers to design our proprietary technologies. Although we take steps to ensure that our engineers do not include open source software in the technologies they design, we may not exercise complete control over the product development efforts of our engineers and we cannot be certain that they have not incorporated open source software into our proprietary technologies. In the event that portions of our proprietary technologies are determined to be subject to an open source license, we might be required to publicly release the affected portions of our source code, which could reduce or eliminate our ability to commercialize our solutions. Also, our ability
to market our type and technologies depends in part on the existence of proprietary operating systems. If freely distributed operating systems like Linux or Android become more prevalent, the need for our solutions may diminish and our revenue could be adversely affected. Finally, in the event we develop technologies that operate under or are delivered under an open source license, such technologies may have little or no direct financial benefit to us.
Risks Related to Our Customers and our Customer Relationships
We face pressure from our customers to lower our license fees and, to the extent we lower them in the future, our revenue may be adversely affected.
The consumer device markets are highly competitive and consumer device manufacturers are continually looking for ways to reduce the costs of components included in their products in order to maintain or broaden consumer acceptance of those products. Because our type and technologies are a component incorporated into consumer devices, when negotiating renewals of customer contracts, we face pressure from our customers to lower our license fees. In addition, our Creative Professional business is increasingly comprised of recurring revenue, including subscription-based licensing models. We have in the past, and may in the future, need to lower our recurring license fees, either immediately or over time, to preserve customer relationships or extend use of our type or technologies. To the extent contractual license fees for any particular customer are lower in the future, we cannot be certain that we will be able to achieve related increases in the use of our type or technologies or other benefits to fully offset the effects of these reduced revenues.
If we are unable to further penetrate our existing markets, expand into new markets or adapt or develop our products and services, our business prospects could be limited.
In our Creative Professional business, we expect that our future success will depend, in part, upon our ability to successfully license our existing design assets into additional large enterprises, especially in new geographic regions where we have not historically had a direct presence. In addition, as business and consumer communication trends evolve, our success will also depend on our ability to pursue new design asset classes. Finally, to date, we have primarily engaged with the designers and creative teams within a brands marketing group. However, our success will depend on our ability to connect with the broader concerns facing a brands chief marketing officer.
In our OEM business, we expect that our future success will depend, in part, upon our ability to successfully transition from offering a primarily embedded software solution to a holistic offering that includes design and marketing, as well as continuing to penetrate existing markets for devices with displays including mobile devices, e-book readers, automotive displays, digital televisions, set-top boxes and consumer appliances. Our ability to grow our revenue depends upon our ability to further penetrate these markets and to successfully penetrate those markets in which we currently have no presence.
Demand for our solutions in any of these developing markets may not develop or grow, and a sufficiently broad base of Creative Professional and OEM customers may not adopt or continue to use products that employ our solutions. Because of our limited experience in some of these markets, we may not be able to adequately adapt our business and our solutions to the needs of these customers.
Our success depends on the existence of a market for consumer devices that incorporate our type and technologies.
The consumer device market is characterized by rapidly changing technology, evolving industry standards and needs, and frequent new platform and product introductions. If the need for laser printers and other consumer devices utilizing our technology were to decrease or if current models of these products were replaced by new or existing products for which we do not have a competitive solution or if our solutions are replaced by others that become the industry standard and we are not able to develop technologies to build on such industry standards, our customers may not purchase our solutions and our revenue would be adversely affected. For example, if consumer devices evolve from text-based screens to voice controlled or gesture activated interactions, our solutions may be less relevant to the device manufacturers.
A significant portion of our revenue in 2017, 2016 and 2015 was derived from laser printer manufacturers. The laser printer market is a mature market and as a result, it has grown at a slower rate than other markets in which we operate. Although we have taken some steps to become less dependent on the volume of printer unit sales, our licensing revenue from OEMs is still dependent on the overall demand for printers. If sales of printers incorporating our solutions level off or decline over time, then our licensing revenue may be adversely affected.
Our licensing revenue from OEMs depends upon the extent to which these device manufacturers embed our type and technologies in their products. We do not control their decision whether or not to embed our solutions into their products, and we do not control their product development or commercialization efforts. If we fail to develop and offer solutions that adequately or competitively address the needs of the changing marketplace, OEMs may not be willing to embed our solutions into their products. The process utilized by OEMs to design, develop, produce and sell their products is generally 12 to 24 months in duration. As a result, if an OEM is unwilling or unable to embed our solutions into a product that it is manufacturing or developing, we may experience significant delays in generating revenue while we wait for that OEM to begin development of a new product that may embed our solutions. In addition, if OEMs sell fewer products incorporating our solutions, our revenue will be adversely affected.
We derive a substantial majority of our revenue from a limited number of licensees, and if we are unable to maintain these customer relationships or attract additional customers, our revenue will be adversely affected.
We derive a large percentage of our revenue and profitability from the licensing of our type and technologies to Creative Professionals who use our fonts in the content that they
create and OEMs, including ISVs. Some of our license agreements are for a limited period of time and, upon expiration of their license agreements, these customers may not renew their agreements or may elect not to enter into new agreements with us on terms as favorable as our current agreements. Moreover, the terms of some of these agreements may be more favorable to us than others. If there is consolidation, for example, through acquisition, within any of the markets that we serve, our financial results may be adversely impacted. In addition, for the years ended December 31, 2017, 2016 and 2015, our top ten licensees by revenue accounted for approximately 27.3%, 30.3% and 33.5% of our total revenue, respectively. Accordingly, if we are unable to maintain these relationships or establish relationships with new customers, our licensing revenue will be adversely affected.
If standard setting industry leaders were to fail to incorporate, or discontinue their use of, our solutions in their products, our business could be materially and adversely affected.
Major players in our industry have the capacity to dictate business models, technology standards and access to customers. To the extent these industry leaders do not incorporate our solutions into their offerings, we may not be successful in penetrating the markets we target. For example, because of their market position as industry leaders, the incorporation by Hewlett Packard, or HP, of our solutions in its laser printers and the incorporation of our solutions by Adobe in its PostScript product promote widespread adoption of our technologies by manufacturers seeking to maintain compatibility with HP and Adobe. If HP or Adobe were to stop using our solutions in their products, the market acceptance of our technologies by other consumer device manufacturers would be materially and adversely affected, and this would in turn adversely affect our revenue.
Our operating results may fluctuate based upon an increase or decrease of market share by consumer device manufacturers to whom we license our type or technologies.
The terms of our license agreements with our consumer device manufacturers vary. For example, we have fixed fee licensing agreements with certain customers, some of which may decline over time or which may not be renewed at the end of the current term. If these customers, some of whom are instrumental in setting industry standards and influencing early adoption of platforms or technology incorporating our solutions, were to increase their share of the consumer device market, under the terms of these agreements there would not be a corresponding increase in our revenue. Any change in the market share of consumer device manufacturers to whom we license our type or technologies is entirely outside of our control.
Risks Related to Our Business Operations
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 seven 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 2017, 2016 and 2015, approximately 56.9%, 58.3% and 45.5%, respectively, of our total revenue was derived from operations outside the U.S. and we expect that international sales will continue to represent a substantial portion of our revenue for the foreseeable future. This future international revenue will depend on the continued use and expansion of our type and technologies, including the licensing of our solutions worldwide.
We are subject to the risks of conducting business internationally, including:
If we have difficulty finding appropriate partnership and/or acquisition candidates, our ability to execute aspects of our strategic plan may be hindered and, if we do find appropriate acquisition candidates, we may fail to realize the anticipated value of the acquisition.
We intend to pursue selectively complementary acquisitions, strategic partnerships, and third party intellectual property licenses to accelerate our time to market, penetrate new geographies and expand our offering. Execution of our strategy relies on finding and closing partnerships and/or acquisitions that fit with our business and that meet our financial expectations. To the extent that we are unable to identify appropriate opportunities and close deals on acceptable financial terms, we may face hurdles in executing portions of our strategy. In addition, the pursuit of potential acquisitions may divert the attention of management and cause us to incur various expenses in identifying, investigating and pursuing suitable acquisitions, whether or not they are consummated.
Completed acquisitions could create risks for us, including:
We rely on certain customers to whom we license our design assets and technologies to prepare accurate reports for our determination of licensing revenue, including any revenue sharing obligations, and if these reports are inaccurate, our revenue may be under-, or over-stated and our forecasts and budgets may be incorrect.
Our revenue is generated primarily from royalties and recurring revenues paid by customers who license our design assets and technologies. Under certain of these arrangements, our customers pay us a fee based on usage of our solutions and we rely on our licensees to accurately report their usage. We calculate our license fees, prepare our financial reports, projections and budgets and direct our licensing and technology development efforts based in part on these reports. However, it is often difficult for us to independently determine whether or not our customers are reporting accurately. We have implemented an audit program of our licensees records, but the effects of this program may be limited as audits are generally expensive and time consuming, and initiating audits could harm our relationships with our customers. In addition, our audit rights are contractually limited. To the extent that these customers understate or fail to report their usage of their solutions, we will not collect and recognize revenue to which we are entitled. Alternatively, we may encounter circumstances in which a customer may notify us that it previously reported inaccurate usage. In such cases, we may be required to give our customer a credit which would result in a reduction in revenue in the period in which a credit is granted, and such a reduction could be material.
Parties from whom we license fonts or components of our technologies may challenge the basis for our calculations of the royalties due to them.
Some of our agreements with licensors require us to give them the right to audit our calculations of royalties payable to them. In addition, licensors may at any time challenge the basis of our calculations and we cannot be sure that we will be successful in our defense. Any royalties paid as a result of any successful challenge would increase our expenses and could negatively impact our relationship with such licensor, including by impairing our ability to continue to use and re-license technologies or fonts from that licensor.
Changing laws and regulations could affect our operating results.
Our adoption of the new U.S. revenue recognition accounting rules on January 1, 2018 may impact our ability to correctly and timely report our financial results. While we do not expect to encounter any issues, the quarter ending March 31, 2018 will be our first time using the system for both accounting and reporting purposes.
In connection with our products and services and sometimes on behalf of our customers, we and certain third party service providers with which we have business relationships may collect, use, process, store, share, retain and transfer personally identifiable information (PII) that is derived from the activities of our end users in various channels, including traditional, mobile and e-commerce websites, mobile and desktop applications, social media, software products, email interactions and text messaging, as well as other users of social media platforms. Transferring PII across borders is complex and in certain jurisdictions, is highly regulated. Worldwide, new laws (such as the EU General Data Protection Regulation), regulations, policies, official guidance, standards and industry self-regulatory codes governing how companies handle PII have been enacted and more are being considered that may affect or limit our ability to reach current or prospective customers, respond to requests for access to PII, or to fully implement our business models. Governments, privacy advocates, class action attorneys and the media are increasingly scrutinizing how companies collect, use, process, store, share, retain and transfer PII. Agency enforcement actions and court decisions may be binding on companies that collect, use, process, store, retain and transfer PII. As these laws, regulations, policies, guidance, standards and self-regulatory codes, evolve, along with societal norms around data privacy and information governance, they may be inconsistent from jurisdiction to jurisdiction, and complying with these emerging and changing international requirements may cause us to incur substantial costs. Further, noncompliance could result in significant penalties or legal liability, including significant financial penalties and reputational harm, and could cause us to have to change our business models or inhibit us from implementing our business models effectively.
Our compliance with privacy laws, regulations, policies, guidance, standards and self-regulatory codes, and our reputation among our end users and the public, also depend in part on our customers and service providers adherence to privacy laws and regulations and their use of the PII collected on our behalf or via our products and services in ways consistent with applicable privacy laws and consumers expectations. We rely on contractual representations made to us by these customers and service providers that their use of the PII collected via our products or services or on our behalf do not violate any applicable privacy laws, rules and regulations or their own privacy policies. We do not formally audit such customers to confirm compliance with these representations. If these representations are false or if these parties do not otherwise comply with applicable privacy laws, we could face adverse publicity and possible legal or other regulatory action, including significant fines.
Any perception of our practices, products or services as an invasion of privacy, whether or not consistent with current laws, regulations and industry practices, may subject us to public criticism, class action lawsuits, reputational harm and/or claims by regulators, industry groups or other third parties, all of which could disrupt our business, expose us to increased liability and affect the demand for our products and services.
We have incurred and will incur significant costs, and have and could experience internal resources constraints, associated with the evaluation of and compliance with evolving corporate governance, reporting and other requirements, including requirements under the Sarbanes-Oxley Act and the Massachusetts data protection laws, as well as rules implemented by the SEC and the NASDAQ Global Select Market. In addition, we may incur costs associated with complying with changing laws and regulations governing the operation of a business and the use of customer data in the regions in which we operate. The expenses incurred by public companies for reporting and corporate governance purposes have been increasing. We expect that the rules and regulations applicable to us could cause our legal and financial compliance costs to increase and could make some activities more time-consuming and costly. In addition, in the current public company environment, officers and directors are subject to increased scrutiny and may be subject to increased potential liability. As a result, it may be more difficult for us to attract and retain qualified individuals to serve on our board of directors or as our executive officers. This could negatively impact our future success.
A prolonged economic downturn could materially harm our business.
Our ability to generate revenue is affected by the level of business activity of our Creative Professional and OEM customers, which, in most cases, is affected by the level of economic activity occurring in the industries and markets that our customers serve. Negative trends in the general economy, including trends resulting from a recession, the availability of credit, actual or threatened military action by the United States, terrorist attacks on the United States or abroad, could cause a decrease in consumer and/or business spending and could negatively affect the rate of growth of consumer device markets or of adoption of consumer devices. Any economic downturn, including a reduction in consumer confidence or disposable income in general, could also adversely affect the demand for, or impair the ability of our customers to pay for, the products and services that they have purchased from us. We cannot predict the timing, strength or duration of any economic slowdown or subsequent economic recovery and this uncertainty makes it difficult to determine if past experience is a good guide to the future. If the general economy or markets in which we operate worsen from present levels, the demand for our products and services could decline, and our revenue and profitability could be materially and adversely impacted.
Security vulnerabilities in our products or systems could lead to reduced revenues or to liability claims.
Maintaining the security of our products, computers and networks, including data centers that house our equipment and deliver our services, is an important issue for us and our customers. Unauthorized parties may be able to develop and deploy viruses, worms, malware and other malicious software programs that attack our products and services, our networks, or otherwise exploit any security vulnerabilities of our products, services and
networks. Hardware, software and applications including cloud-based solutions that we procure from third parties may contain defects in design or manufacture, including bugs and other problems that could unexpectedly compromise the security of the system. Because techniques used by unauthorized parties to obtain unauthorized access to or sabotage systems change frequently and generally are not recognized until long after being launched against a target, we may be unable to anticipate these techniques or to implement adequate preventative measures. We can make no assurance that we will be able to detect, prevent, timely and adequately address, or mitigate the negative effects of cyberattacks or other security breaches, and we cannot guarantee that our systems will not be compromised, whether as a result of criminal conduct, advances in computer hacking, service disruptions, or data security incidents due to employee error, malfeasance, or other vulnerabilities. Any of these occurrences, whether intentional or accidental, could lead to interruptions, delays, or cessation of operation of our products, services and networks.
Unauthorized parties may seek to, among other things, misappropriate, compromise or alter our intellectual property, our confidential information, or confidential information of third parties including our customers; create system disruptions or product or service vulnerabilities; or cause shutdowns. Unauthorized disclosure, misuse, loss or corruption of our data, damage or misuse of our computer systems, or the inability of our customers to access or use our systems and solutions could disrupt our operations, result in a material loss of business, expose us to substantial legal liability, and significantly harm our reputation. Potential breaches of our security measures and the accidental loss, inadvertent disclosure or unauthorized dissemination of proprietary information or sensitive, personal or confidential data about us, our employees or our customers, including the potential loss or disclosure of such information or data as a result of hacking, fraud, trickery or other forms of deception, could expose us, our employees, our customers or the individuals affected to a risk of loss or misuse of this information, result in litigation and potential liability or fines for us, governmental inquiry and oversight, damage our brand and reputation or otherwise harm our business. We may be required to expend significant resources to attempt to protect against security threats, enhance our security measures, or investigate and remediate any security vulnerabilities. If such efforts are unsuccessful, we could experience the disruption of our operations, a material loss of business, exposure to substantial legal liability and significant harm to our reputation.
Our quarterly results may fluctuate significantly.
We expect our operating results to be subject to quarterly fluctuations. The revenue we generate and our operating results will be affected by numerous factors, including:
Our revenue also varies from quarter-to-quarter as a result of variances on the timing of transactions through our e-commerce websites. Quarterly fluctuations in our operating results may, in turn, cause the price of our stock to fluctuate substantially. We believe that quarterly comparisons of our financial results are not necessarily meaningful and should not be relied upon as an indication of our future performance.
The loss of members of our executive and senior management team may prevent us from executing our business strategy.
Our future success depends in large part upon the continued services of key members of our executive and senior management team. Our senior officers bring a diverse skill set to our management team, which we rely on for strategy and direction as the Company grows and diversifies. The loss of the services of any of these key employees could seriously harm our ability to execute our business strategy. Further, all of our officers are at-will employees. The loss of any of these key employees may cause us to incur significant costs in identifying, hiring, training and retaining their replacements.
We rely on highly skilled personnel, and if we are unable to retain or motivate key personnel or hire qualified personnel, or implement the appropriate processes and systems to support them, we may not be able to maintain our operations or grow effectively.
Our performance is largely dependent on the talents and efforts of highly skilled individuals, including font designers who are recognized as leaders in the industry and experienced software engineers. These individuals have acquired specialized knowledge and skills with respect to us and our operations. These individuals can be terminated or can leave our employ at any time. Some of these individuals are consultants. Our ability to hire and retain qualified personnel could impact our capacity to maintain our business, and efforts to grow our business could be hindered. If any of these individuals or a group of individuals were to terminate their employment unexpectedly or end their consulting relationship sooner than anticipated, we could face substantial difficulty in hiring qualified successors, could incur significant costs in connection with their termination and could experience a loss in productivity while any such successor obtains the necessary training and experience.
Our future success depends on our continuing ability to identify, hire, develop, motivate and retain highly skilled personnel and consultants for all areas of our organization to drive the execution of our strategic vision. In this regard, if we are unable to hire, train and support, with internal systems and processes, a sufficient number of qualified employees and consultants for any reason or retain employees or consultants with the required expertise, we may not be able to implement our current initiatives or grow effectively or execute our business strategy successfully.
Risks Related to the Securities Markets and Investment in our Common Stock
Our business could be negatively affected as a result of the actions of activist stockholders.
Shareholder activism, which could take many forms or arise in a variety of situations, has been increasing in publicly traded companies recently. On October 6, 2017, we were notified
that various funds affiliated with Starboard Value, BLR Partners LP and FMLP Inc. (collectively, the Starboard Group), had obtained a significant stake in our Company for the purposes of (i) engaging in discussions with the Company regarding operating results, cost and capital allocation, opportunities to enhance stockholder value and corporate governance, (ii) taking all action necessary to achieve the foregoing and (iii) taking any other actions the Starboard Group determines to undertake in connection with their respective investment in the Company, including, but not limited to, a potential solicitation of proxies in furtherance of seeking representation on the Board of Directors of the Company. Although Starboard Group significantly reduced their stake in our Company on February 16, 2018, other activists, either working alone or collectively in a group, may obtain a significant stake in our Company. Considering and responding to any proposals from activist stockholders, including potential proxy contests, could result in substantial costs and divert managements and our Board of Directors attention and resources from our business. We have incurred, and expect to continue to incur in the first quarter of 2018, significant legal and advisory fees related to the activist stockholder matters. Additionally, such stockholder activism could give rise to perceived uncertainties as to our future, adversely affect our relationships with customers and service providers, make it more difficult to attract and retain qualified personnel, and cause our stock price to experience periods of volatility.
Market volatility may affect our stock price and the value of your investment.
The market price of our common stock may fluctuate significantly in response to a number of factors, most of which we cannot control, including:
Market prices of technology companies have been extremely volatile. Stock prices of many technology companies have often fluctuated in a manner unrelated or disproportionate to the operating performance of such companies. In the past, following periods of market volatility, stockholders have often instituted securities class action litigation. If we were involved in securities litigation, it could have a substantial cost and divert resources and the attention of management from our business.
The structure of our current Credit Facility could affect our financing options and liquidity.
We have a five-year, $150.0 million secured revolving credit facility (the Credit Facility) with Silicon Valley Bank, the administrative agent for a syndicate of lenders. Borrowings under the Credit Facility bear interest at a variable rate based upon, at the Companys option, either London Interbank Offering Rate, (LIBOR) or the base rate, plus in each case, an applicable margin. The Credit Facility contains certain financial covenants and is secured by substantially all of our assets. Draw downs on the Credit Facility could have important consequences to our business or the holders of our common stock, including:
Anti-takeover provisions in our charter documents and under Delaware law could make an acquisition of us, which may be beneficial to our stockholders, more difficult and may inhibit attempts by our stockholders to replace or remove our current management.
Provisions in our certificate of incorporation and by-laws may delay or prevent an acquisition of us or a change in our management. These provisions include a classified board of directors, a prohibition on actions by written consent of our stockholders and the ability of our board of directors to issue preferred stock without stockholder approval. In addition, because we are incorporated in Delaware, we are governed by the provisions of Section 203 of the Delaware General Corporation Law, which limits the ability of stockholders owning in excess of 15% of our outstanding voting stock to merge or combine with us. Although we believe these provisions collectively provide for an opportunity to obtain greater value for stockholders by requiring potential acquirers to negotiate with our board of directors, they would apply even if an offer rejected by our board were considered beneficial by some stockholders. In addition, these provisions may frustrate or prevent any attempts by our stockholders to replace or remove our current management by making it more difficult for stockholders to replace members of our board of directors, which is responsible for appointing the members of our management.
We currently pay dividends on our common stock, but there is no guarantee that this will continue.
Since the third quarter of 2012, our Board of Directors has approved a quarterly dividend to shareholders of our common stock. Future payments and record dates are subject to board approval. However, if our financial or operating conditions change, or if we fail to satisfy the restrictive covenants contained in the terms of our Credit Facility that limit our ability to make dividend payments, it may affect our ability to pay dividends on a quarterly basis or at all.
We may require additional capital, and raising additional funds by issuing securities or additional debt financing may cause dilution to existing stockholders, restrict our operations or require us to relinquish proprietary rights.
We may need to raise additional capital in the future. We may raise additional funds through public or private equity offerings or debt financings. To the extent that we raise
additional capital by issuing equity securities, our existing stockholders ownership will be diluted. Any new debt financing we enter into may involve covenants that restrict our operations more than our current credit facility. These restrictive covenants would likely include limitations on additional borrowing, specific restrictions on the use of our assets and our ability to pay dividends, as well as prohibitions on our ability to create liens, make investments or repurchase stock.
If securities analysts do not publish research or reports about our business or if they publish negative evaluations of our stock, the price of our stock could decline.
The trading market for our common stock relies, in part, on the research and reports that industry or financial analysts publish about us or our business. Although we have obtained analyst coverage, if one or more of the analysts covering our business downgrade their evaluations of our stock, the price of our stock could decline. If one or more of these analysts cease to cover our stock, we could lose visibility in the market for our stock, which in turn could cause our stock price to decline.
The principal leased properties of the Company and its subsidiaries are listed in the table below.
We also maintain seventeen additional leased facilities in San Francisco, Los Altos and Los Angeles, California; Boulder, Colorado; Elk Grove Village and Chicago, Illinois; New York City, New York; Salfords and London, United Kingdom; Bad Homburg and Berlin, Germany; Shanghai and Hong Kong, China, Seoul, South Korea; and Tokyo, Japan. These additional
offices occupy approximately 53,000 square feet in the aggregate. We do not consider any specific leased facility to be material to our operations. We believe equally suited facilities are available in several other areas throughout the United States and abroad.
From time to time, we may be a party to various claims, suits and complaints. We do not believe that there are claims or legal proceedings that, if determined adversely to us, would have a material adverse effect on our business, results of operations or financial condition.
Market Information and Related Stockholder Matters
Our common shares, $0.001 par value, trade on the NASDAQ Global Select Market.
The following table sets forth, for the periods indicated, the high and low closing sales prices per share of our common stock as reported by the NASDAQ Global Select Market.
The closing price of our common stock, as reported by the NASDAQ Global Select Market, was $25.35 on February 20, 2018.
As of February 20, 2018, there were approximately 466 holders of record of our common stock.
The following table sets forth, for the dates indicated, dividends declared on our common stock.
The Company paid a total of $18.8 million and $17.5 million in dividends during 2017 and 2016, respectively. We anticipate paying cash dividends on a quarterly basis in the future, subject to approval by our Board of Directors. On February 14, 2018, our Board of Directors declared a $0.116 per share, or approximately $4.9 million, quarterly cash dividend on our outstanding common stock.
Securities Authorized for Issuance Under Equity Compensation Plans
The following table sets forth information regarding securities authorized for issuance under the Companys equity compensation plans as of December 31, 2017. To date, the Company has not granted any warrants or rights.
The Company is subject to the listing requirements of the NASDAQ Global Select Market.
This performance graph shall not be deemed filed with the SEC or subject to Section 18 of the Exchange Act, nor shall it be deemed incorporated by reference in any of our filings under the Securities Act.
The following graph shows a comparison from December 31, 2012 through December 31, 2017 of the cumulative total return for our common stock, NASDAQ Composite Index and NASDAQ Computer Index. Such returns are based on historical results and are not intended to suggest future performance. Data assumes that dividends, if any, were reinvested.
Unregistered Sales of Equity Securities
On August 9, 2016, in connection with our acquisition of Olapic, Inc., we issued an aggregate of 712,116 shares of our restricted common stock as inducement awards to one hundred eight employees of Olapic, Inc. who became employees of the Company. On January 30, 2015, in connection with our acquisition of Swyft Media, we issued an aggregate of 53,520 shares of our restricted common stock as inducement awards to two employees of Swyft Media who became employees of the Company. These issuances were made in compliance with NASDAQ Marketplace Rule 5635(c) and in reliance upon exemptions from registration provided by Section 4(2) of the Securities Act.
Issuer Purchases of Securities
Pursuant to the terms of our 2007 Award Plan and 2010 Inducement Stock Plan, or 2010 Inducement Plan, we automatically reacquire any unvested restricted shares at their original price from the grantee upon termination of employment. The following table provides information about purchases by the Company during the quarter ended December 31, 2017 of equity securities that are registered by the Company pursuant to Section 12 of the Exchange Act:
Monotype Imaging Holdings Inc. Purchases of Equity Securities
The following selected consolidated financial data should be read in conjunction with our consolidated financial statements and related notes and Managements Discussion and Analysis of Financial Condition and Results of Operations appearing elsewhere in this report. The data presented for the years ended December 31, 2017, 2016 and 2015, and as of December 31, 2017 and 2016, are derived from our audited consolidated financial statements included elsewhere in this report. The data presented for the years ended December 31, 2014 and 2013, and as of December 31, 2015, 2014 and 2013, are derived from our consolidated financial statements not included in this report.
You should read the following discussion and analysis of our financial condition and results of operations in conjunction with our consolidated financial statements and notes to those statements, appearing elsewhere in this report. This report contains forward-looking statements reflecting our current expectations that involve risks and uncertainties, such as statements of our plans, objectives, expectations and intentions. The cautionary statements made in this report should be read as applying to all related forward-looking statements wherever they appear in this report. Our actual results may differ materially from those indicated in the forward-looking statements due to a number of factors, including those discussed in Item 1A, Risk Factors and elsewhere in this report.
We are a leading global provider of design assets, technology and expertise that are designed to enable the best user experiences, ensure brand integrity and help companies engage their best customers. We empower expression and engagement for creatives, designers, engineers and marketers at the worlds most revered brands. Monotype is home to some of the worlds most well-known typeface collections. We provide high-quality creative assets and technology solutions to marketers and content creators that empower our customers to achieve global brand fidelity and drive consistent user experiences across a wide variety of devices and online media. Along with our custom type services, our solutions enable consumers and professionals to express their creativity, while our tools and technologies improve creative workflows and maximize efficiency as content is published or distributed. Our solutions provide worldwide language coverage and high-quality text, and our embedded solutions support compelling user interfaces. We offer more than 14,000 typeface designs, and include some of the worlds most widely used designs, such as the Times New Roman®, Helvetica®, Frutiger®, ITC Franklin Gothic, FF Meta and Droid typefaces, and support more than 250 Latin and non-Latin languages. Our e-commerce websites, including myfonts.com, fonts.com, linotype.com, and fontshop.com, which attracted more than 50 million visitors in 2017 from over 200 countries and territories, offer thousands of high-quality font products including our own fonts from the Monotype Libraries, as well as fonts from third parties.
On August 9, 2016, the Company purchased all of the outstanding shares of Olapic, Inc., a privately-held company located in New York, New York; its wholly-owned subsidiaries Olapic UK Ltd., based in London, England; and Olapic Argentina S.A., based in Córdoba, Argentina. Olapic is a provider of a leading visual commerce platform for collecting, curating,
showcasing and measuring crowd sourced photos and videos. Olapics Earned Content Platform helps brands collect, curate, use and analyze user-generated content in the form of images and videos in their ecommerce experiences and across multiple marketing channels. This allows consumers to make more educated purchasing decisions, discover new products and connect to the brands community. Olapic leverages photos and videos from social network sites to help to create powerful branded experiences that drive consumer engagement and increase conversions. The Company acquired Olapic for an aggregate purchase price of approximately $123.7 million, net of cash acquired, consisted of approximately $13.7 million in cash and $110.0 million borrowed from its line of credit. The merger agreement included an additional $9.0 million of consideration that has been placed in escrow and will be paid to the founders of Olapic contingent upon continued employment with the Company. Accordingly, this amount will be recognized as compensation expense over the service period contractually required to earn such amounts, which is $3.0 million after twenty four months and the remainder after thirty six months from the acquisition date. Monotype issued approximately $17.1 million of a combination of restricted stock awards or restricted stock units to the founders and employees of Olapic. These awards will vest over time based on continued employment, and accordingly will be accounted for as compensation expense. Seventy five employees from Olapics U.S. operations, eighty five employees from Olapics Argentina operations and forty one UK and European employees joined the Company in connection with the acquisition. The results of operations of Olapic have been included in our consolidated results and revenue is included within the Creative Professional market beginning on August 9, 2016, the date of acquisition. In connection with the acquisition, we recorded $89.6 million of goodwill. The goodwill reflects the value of the synergies we expect to realize and the assembled workforce. The acquisition of Olapic was structured in such a manner that the goodwill is not expected to be deductible for tax purposes. The purchase price has been allocated to the tangible and intangible assets acquired and liabilities assumed based upon the respective estimates of fair value as of the date of the acquisition and using assumptions that the Companys management believes are reasonable given the information available.
Sources of Revenue
We derive revenue from two principal sources: licensing our design assets and technology to brands and creative professionals, which we refer to as our Creative Professional revenue, and licensing our text imaging solutions to consumer device manufacturers and independent software vendors, which we refer to as our OEM revenue. We derive our Creative Professional revenue primarily from brands, agencies, publishers, corporations, enterprises, small businesses and individuals. We derive our OEM revenue primarily from consumer device manufacturers. Some of our revenue streams, particularly project-related and custom font design revenue where spending is largely discretionary in nature, have historically been and we expect them to continue to be in the future, susceptible to weakening economic conditions.
Our customers are located in the United States, Asia, Europe, and throughout the rest of the world, and our operating subsidiaries are located in the United States, Argentina, the United Kingdom, Germany, India, China and Japan. We are dependent on international sales by our foreign operating subsidiaries for a substantial amount of our total revenue. Revenue from our subsidiary in China is generally from Asian customers and revenue from our other subsidiaries is from customers in a number of different countries, including the United States.
Effective as of January 1, 2017, our presentation of geographic revenue has been changed to better align with how our business operates. As a result, we now report revenue based on
the geographic location of our customers, rather than 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 the Republic of Korea, but the sales are received and recorded by our subsidiary located in the United States. Historically, in the table below such revenues would be included in the revenue for the United States, whereas for our new presentation, such revenues would be reported in the Republic of Korea and included in the revenue for Rest of World. Geographic revenue for the year ended 2016 has been restated to conform to this presentation. Revenue for the year ended 2015 has not been restated as it is impracticable to do so.
For the years ended December 31, 2017 and 2016, revenue from customers located outside the United States comprised 56.9% and 58.3%, respectively, of our total revenue. For the year ended December 31, 2015, sales by our subsidiaries located outside the United States comprised of 45.5% of our total revenue. We expect that sales by our international subsidiaries will continue to represent a substantial portion of our revenue for the foreseeable future. Future international revenue will depend on the continued use and expansion of our design assets and technology worldwide.
We derive a significant portion of our OEM revenue from a limited number of customers, in particular manufacturers of laser printers and consumer electronic devices. For the years ended December 31, 2017, 2016 and 2015, our top ten licensees by revenue accounted for approximately 27.3%, 30.3% and 33.5% of our total revenue, respectively. No one customer accounted for more than 10% of our total revenue in 2017, 2016 or 2015. For the quarters ended December 31, 2017, 2016 and 2015, no customer individually accounted for more than 10% of our total revenue.
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 font design services and cloud-based web services costs related to our SaaS-based offerings. License fees that we pay to third parties are typically based on a percentage of our Creative Professional and OEM revenue and do not involve minimum fees. Our cost of OEM revenue has typically had a lower cost 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. We have achieved improved margins on our Creative Professional revenue as a result of product mix and lower royalty rates. In addition, Creative Professional revenue includes custom font design service revenue, which has a substantially higher cost than our other revenue. Our gross profit margin may vary depending on the mix of revenue between sales of our fonts and sales of third party fonts, and depending on the level of custom font design service revenue.
Cost of revenue also includes amortization of acquired technology, which we amortize over 7 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.
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. In addition, within our Creative Professional business, the cost of our custom font design service revenue is substantially higher than the cost of our other revenue. The relative cost of our Creative Professional revenue has decreased in recent periods, as efforts to sell license rights to more fonts that we own have been successful, and because we have recently experienced success in our effort to sell certain license rights that carry lower royalty rates to Creative Professional customers. Our Creative Professional revenue is growing at a faster rate than our OEM revenue. We expect these trends to continue. Our gross profit is subject to variability from period-to-period, depending on the product mix and the level of custom font design service revenue.
Marketing and Selling
Our marketing and selling expense consists of salaries, bonuses, commissions and benefits related to our marketing and selling personnel, business travel expenses, advertising and trade show expenses, web-related expenses, allocated facilities costs and other overhead expenses. Sales commission expense varies as a function of revenue and goal achievement from period-to-period.
Research and Development
Our research and development expense consists of salaries, bonuses and benefits related to our research and development, engineering, font design and integration support personnel and their business travel expenses, license fees related to certain of our technology licenses, expenses for contracted services and allocated facilities costs and other overhead expenses. Our research and development expense in a given period may be reduced to the extent that internal engineering resources are allocated to cost of revenue for custom design services.
Our research and development is primarily focused on enhancing the functionality of our fonts and technology solutions, and developing new products. From time-to-time, we license third-party font technology in connection with new technology development projects that are part of our research and development efforts. Our research and development costs are expensed as incurred.
General and Administrative
Our general and administrative expense consists of salaries, bonuses and benefits related to our general and administrative personnel, accounting, legal and other professional fees, allocated facilities costs and other overhead expenses and insurance costs.
Amortization of Intangible Assets
We amortize intangible assets acquired as follows:
For purposes of amortization, we estimate the life of customer relationships based upon various considerations, including our knowledge of the industry and the marketplace in which we operate. We amortize non-compete agreements over the stated life of the agreement. We use the straight-line method to amortize our intangible assets. 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.
Critical Accounting Policies
The preparation of financial statements and related disclosures in conformity with generally accepted accounting principles in the United States, or 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.
We believe the following critical accounting policies affect our more significant judgments used in the preparation of our consolidated financial statements. Additional information about our critical accounting policies may be found in Note 2 to our consolidated financial statements in Item 8 of this Annual Report on Form 10-K.
We recognize revenue in accordance with ASC Topic No. 985-605, Software Revenue Recognition. Revenue is recognized when persuasive evidence of an agreement exists, the product has been delivered or services have been provided, the fee is fixed or determinable and collection of the fee is probable. However, determining whether and when some of these criteria have been satisfied often involves assumptions and judgments that can have a significant impact on the timing and amount of revenues the Company reports. For example,
the Company often receives multiple purchase orders or contracts from a single customer or a group of related parties that are evaluated to determine if they are, in effect, parts of a single arrangement. If they are determined to be parts of a single arrangement, revenues are recorded as if a single multiple-element arrangement exists. In addition, arrangements with customers may include multiple deliverables, or multiple elements in a single purchase order or contract. The fee for such arrangement is allocated to the various elements based on vendor-specific objective evidence of fair value, or VSOE, and revenue is recognized accordingly. In the absence of VSOE, all revenue from the arrangement is deferred until the earlier of the point at which (a) such sufficient VSOE does exist, or (b) all elements of the arrangement have been delivered. In certain circumstances, the revenue is recognized ratably, in accordance with the revenue recognition guidance.
Creative Professional Revenue
Our Creative Professional revenue is primarily derived from font licenses, font related services and from custom font design services. We license fonts directly to end-users through our direct sales organization, e-commerce websites and indirectly through third-party resellers. Web font and digital ad related services refer to our web font services and web design tools. Our customers include graphic designers, advertising agencies, media organizations and corporations. In addition, Creative Professional revenue includes revenue derived from our software as a service, or SaaS, offerings.
Revenue from font licenses to our e-commerce customers is recognized upon payment by the customer and when the software embodying the font is shipped or made available. 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, unless it is part of a bundled services arrangement, in which case, it is recognized over the longest service period, or accounted for on a percentage-of-completion basis where appropriate. Web font and digital ad service revenue is mainly self-hosted and recorded upon delivery. Revenue from Olapics Earned Content platform is a SaaS-based, subscription model. Company hosted subscription-based arrangements and our SaaS products are accounted for as subscription revenue, recognized ratably over the subscription period. The Companys SaaS arrangements provide customers the right to access its hosted software applications and our customers do not have the right to take possession of the Companys software during the hosting arrangement.
Web server and commercial rights to online fonts is considered recurring revenue and is recognized upon payment by the customer and proof of font delivery, and when all other revenue recognition criteria have been met. Contract accounting, completed contract for short-term projects and percentage-of-completion for long-term projects, is used where services are deemed essential to the software.
Our OEM revenue is derived substantially from printer imaging, printer driver and display imaging products. Under our licensing arrangements, we either receive a royalty for each product unit incorporating our fonts and technology that is shipped by our OEM customers or a fixed fee as specified under license arrangements with certain of our OEM customers. Fixed fee licensing arrangements are not based on units shipped by the customer, but instead, customers pay us on a periodic basis for the right to embed our fonts and
technology in their products over a certain term. Although 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 fonts and technology in their products, and for font development. Many of our per-unit royalty licenses continue for the duration that our OEM customers ship products that include our technology, unless terminated for breach. Other licenses have terms that typically range from one fiscal quarter to five years, and usually provide for automatic or optional renewals. We recognize revenue from per-unit royalties in the period during which we receive a royalty report from a customer, typically one quarter after royalty-bearing units are shipped, as we do not have the ability to estimate the number of units shipped by our customers. 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, is not bundled with any time-based elements and collection is probable. OEM revenue also includes project-related agreements for which contract accounting, completed contract for short-term projects and percentage-of-completion for long-term projects, may be used.
Goodwill, Indefinite-Lived Intangible Assets and Long-lived Assets
We record tangible and intangible assets acquired and liabilities assumed in a business combination under the purchase method of accounting. Amounts paid for acquisitions are allocated to the assets acquired and liabilities assumed based on their fair values at the date of acquisition. We allocate the excess of the cost of an acquired entity over the amounts assigned to assets acquired and liabilities assumed in a business combination to goodwill. The value initially assigned to the acquired assets and assumed liabilities, particularly intangible assets and goodwill, are subject to underlying assumptions that require significant management judgment. If different assumptions were used, it could materially impact the purchase price allocation and our financial position and results of operations.
Our chief operating decision maker, or CODM, our president and chief executive officer, assesses performance and makes resource allocation decisions based on our financial performance. The CODM evaluates financial performance measured by revenue on a consolidated and market basis, and by consolidated net adjusted EBITDA. Annual budgeting, hiring and resource allocation are evaluated based on consolidated and market revenue, and consolidated net adjusted EBITDA. As a result primarily of the aforementioned factors, we operate within a single business segment and reporting unit.
We assess the impairment of goodwill and indefinite-lived intangible assets annually, or more frequently if events or changes in circumstances indicate that the carrying value of such assets exceeds their fair value. We perform our annual goodwill and indefinite-lived intangible impairment tests as of December 31. In accordance with Accounting Standards Update, ASU, No. 2011-08, IntangiblesGoodwill and Other (Topic 350): Testing Goodwill for Impairment, we have opted to perform a qualitative assessment of the fair value of the reporting unit. If the Company determines, on the basis of the qualitative factors, that the fair value of the reporting unit is more likely than not less than its carrying value, the quantitative two-step fair value impairment test is required. Otherwise, no further testing is required. Similarly, for indefinite-lived intangible assets, in accordance with ASU No. 2012-02, IntangiblesGoodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment, an entity has the option to first assess qualitative factors to determine whether it is necessary to perform the two-step test. If an entity believes, as a result of its qualitative assessment, that it is more-likely-than-not that the fair value of a reporting unit is less than its carrying amount, the quantitative impairment test is required. Otherwise, the quantitative test is optional for indefinite-lived intangible assets. For both years presented,
2017 and 2016, we assessed qualitative factors of goodwill, as described below, to determine whether it was more likely than not that the fair value of our reporting unit was impaired and determined that the fair value was more likely than not higher than its carrying value. For both years presented, 2017 and 2016, we assessed qualitative factors of our indefinite-lived intangible assets. In both years presented, we determined that the fair value was more likely than not higher that the carrying value.
With respect to both goodwill and indefinite-lived intangible assets, factors that could trigger an impairment review include significant negative industry or economic trends, exiting an activity in conjunction with a restructuring of operations, a sustained decrease in share price or current, historical or projected losses that demonstrate continuing losses associated with an asset. Impairment evaluations involve management estimates of useful lives and future cash flows, including assumptions about future conditions such as future revenue, operating expenses, the fair values of certain assets based on appraisals and industry trends. Actual useful lives and cash flows could be different from those estimated by our management. If this resulted in an impairment of goodwill and indefinite-lived intangible assets, it could have a material adverse effect on our financial position and results of operations.
Stock Based Compensation
We account for stock based compensation in accordance with ASC Topic No. 718, CompensationStock Compensation or ASC 718, 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.
For restricted stock awards and restricted stock units issued under the Companys stock based compensation plans, the fair value of each grant is calculated based on the Companys stock price on the date of grant. For service-based awards, the Company recognizes compensation expense on a straight-line basis over the requisite service period of the award. For performance-based awards, stock based compensation expense is recognized over the expected performance achievement period of individual performance milestones, when the achievement of each individual performance milestone becomes probable.
The Company uses the Black-Scholes option pricing model to determine the weighted-average fair value of options granted and recognizes the compensation cost of stock based awards on a straight-line basis over the vesting period of the award. The determination of the fair value of stock based payment awards using the Black-Scholes model are affected by our stock price and a number of assumptions, including expected volatility, expected life, risk-free interest rate and expected dividends. We estimate volatility based on our own stock price history. The expected life of awards is estimated based on actual historical exercise behavior of our employees. The risk-free interest rate assumption is based on a U.S. treasury instrument whose term is consistent with the expected life of our awards. The expected dividend yield assumption is based on the actual annual yield.
In 2017, we elected to account for forfeitures when they occur, on a modified retrospective basis in connection with our adoption of ASU 2016-09, Compensation Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting. As a result of this adoption, $0.6 million of additional stock based compensation expense, net of tax, was recorded to retained earnings on the date of adoption as a cumulative effect adjustment related to our accounting policy change for forfeitures.
In 2016, forfeitures were estimated quarterly. Prior to 2016, forfeitures were estimated at the time of grant and were revised, if necessary, in subsequent periods if actual forfeitures differed from those estimates. Stock based compensation expense recognized in our financial statements is based on awards that are ultimately expected to vest. We evaluate the assumptions used to value our awards on a quarterly basis and if factors change and we employ different assumptions, stock based compensation expense may differ significantly from what we have recorded in the past. If there are any modifications or cancellations of the underlying unvested securities, we may be required to accelerate, increase or cancel any remaining unearned stock based compensation expense. Future stock based compensation expense and unearned stock based compensation will increase to the extent that we grant additional equity awards to employees or we assume unvested equity awards in connection with acquisitions.
During the years ended December 31, 2017, 2016 and 2015, we recorded total stock based compensation of $20.3 million, $17.3 million and $13.7 million, respectively. In 2017, approximately $20.1 million of the $20.3 million was expensed, and in 2015, approximately $13.6 million of the $13.7 million was expensed. In 2016, all of the $17.3 million was expensed. See Note 13 for further details. As of December 31, 2017, the Company had $35.0 million of unrecognized compensation expense related to employees unvested stock options and employees and directors restricted share awards that are expected to be recognized over a weighted-average period of 2.4 years. Some of the restricted stock units granted are subject to performance-based vesting conditions. The vesting for those grants is based on the achievement of specific annual Company revenue targets over three consecutive years; there is no time-based vesting element to these awards. Achievement can be accelerated or cumulative, and some of the awards contain a catch up provision. As of December 31, 2015, it was determined that one annual revenue target associated with the performance-based restricted stock units was probable; accordingly, $0.6 million of stock based compensation expense was recorded in the consolidated statement of income. As of December 31, 2016, it was determined that two separate annual revenue targets associated with the performance-based restricted stock units were probable; accordingly, $1.1 million of compensation expense was recorded in the consolidated statement of income. The remaining performance targets had not been met, and it was determined that it is not probable that the future performance criteria will be met.
We account for our unfunded defined benefit pension plan in accordance with ASC Subtopic No. 715-30, Defined Benefit PlansPension. The pension plan is closed to new participants. The pension plan covers substantially all employees of our German subsidiary who joined our German subsidiary prior to the plan closing in 2006. Benefits under this plan are based on the employees years of service and compensation. We fund the plan sufficiently to meet current benefits only. There are no assets associated with the plan. In each of 2017, 2016 and 2015 we paid $0.1 million to the plan participants. At December 31, 2017 and 2016, our unfunded position was $6.3 million and $5.4 million, respectively. A significant portion of the pension benefit obligation is determined based on the rate of future compensation increases, inflation and interest rates. Given the fact that the pension plan is unfunded, changes in economic and market conditions may require us to increase cash contributions in future years. In addition, changes to our assumptions may materially impact the accrued pension liability.
Provision for Income Taxes
We provide for income taxes in accordance with ASC Topic No. 740, Income Taxes, or ASC 740. Under this method, a deferred tax asset or liability is determined based on the difference between the financial statement and the tax basis of assets and liabilities, as measured by enacted tax rates in effect when these differences are expected to be reversed. This process includes estimating current tax exposure together with assessing temporary differences resulting from differing treatment of items for tax and financial accounting purposes. These differences result in deferred tax assets and liabilities. We also assess the likelihood that our deferred tax assets will be recovered from future taxable income and, to the extent we believe recovery to be unlikely, we have established a valuation allowance. Significant judgment is required in determining the provision for income taxes, deferred tax assets and liabilities and any valuation allowance against our deferred tax assets. Our financial position and results of operations may be materially affected if actual results significantly differ from these estimates or the estimates are adjusted in future periods.
We have recorded a valuation allowance against certain deferred tax assets, including foreign tax credits, where we have determined that their future use is uncertain. ASC 740 requires a valuation allowance be established when it is more likely than not that all or a portion of deferred tax assets will not be realized. A review of all available positive and negative evidence is considered, including a companys performance, the market environment in which the company operates, length of carry-back and carry-forward periods, existing sales backlog, future taxable income projections and tax planning strategies. We have historically provided valuation allowances on certain tax assets, due to the uncertainty of generating taxable income in the appropriate jurisdiction and of the appropriate character to realize such assets. In these instances, the Company has made the determination that it is more likely than not that all or a portion of the deferred tax will not be realized.
We will continue to review our deferred tax position on a periodic basis and will reflect any change in judgment as a discrete item in the related period.
The amount of income taxes we pay is subject to ongoing audits by federal, state and foreign tax authorities, which often result in proposed assessments. Our estimate for the potential outcome for any uncertain tax issue is highly judgmental. We believe we have adequately provided for any reasonably foreseeable outcome related to these matters. However, our future results may include favorable or unfavorable adjustments to our estimated tax liabilities in the period that the assessments are made or resolved, or when the statute of limitations for certain periods expires. As a result, our effective tax rate may fluctuate significantly on a quarterly basis.
As part of the process of preparing our consolidated financial statements, we are required to estimate our income taxes in each of the jurisdictions in which we operate. This process involves estimating our actual current tax expense together with assessing the future impact of temporary differences resulting from differing treatment of items for tax and accounting purposes. The tax effect of these temporary differences is shown on our December 31, 2017 consolidated balance sheet (see Note 11 to our consolidated financial statements) and denotes these differences as a net deferred tax liability of $26.8 million. This consists of total deferred tax liabilities of $44.5 million and net deferred tax assets of $17.7 million after providing a valuation allowance of $6.9 million.
New Tax Legislation
On December 22, 2017, the Tax Cuts and Jobs Act (The Act) was signed into law. This legislation includes significant changes in U.S. tax law, including a reduction in the corporate tax rates and the creation of a territorial tax system with a one-time mandatory tax on previously deferred foreign earnings of U.S. subsidiaries. The legislation reduced the U.S. corporate tax rate from the current rate of 35% to 21% for tax years beginning after December 31, 2017. As a result of the enacted law, the Company was required to revalue deferred tax assets and liabilities existing as of December 31, 2017 from the 35% federal rate in effect through the end of 2017, to the new 21% rate. Accordingly, the Company recorded a current period tax benefit of $16.8 million and a corresponding reduction in the deferred tax liability. In addition, as a result of changes made by The Act related to taxation of foreign source income and the utilization of foreign tax credits, the Company recorded a valuation allowance on foreign tax credit carryforwards of $5.6 million. The new legislation will require the Company to pay tax on the unremitted earnings of its foreign subsidiaries though December 31, 2017. Because of the complexities involved in determining the previously unremitted earnings and profits of all our foreign subsidiaries, the Company is still in the process of obtaining, preparing, and analyzing the required information, as permitted in accordance with Staff Accounting Bulletin No. 118. The Company has recorded an initial estimate of the tax on unremitted earnings of approximately $0.2 million, net of related foreign tax credits. This amount has been further offset by available foreign tax credits, and as a result the net estimated amount payable related to the deemed repatriation of foreign earnings is zero.
Results of Operations
The following table sets forth items in the consolidated statement of income as a percentage of sales for the periods indicated:
Year Ended December 31, 2017 as Compared to Year Ended December 31, 2016
Sales by Market. We view our operations and manage our business as one segment; the development, marketing and licensing of design assets and technologies. Factors used to identify our single segment include the financial information available for evaluation by our chief operating decision maker, our president and chief executive officer, in determining how to allocate resources and assess performance. While our technologies and services are sold to customers in two principal markets Creative Professional and consumer device manufacturers and independent software vendors, together OEM, 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):
Revenue was $235.8 million and $203.4 million for the years ended December 31, 2017 and 2016, respectively, an increase of $32.3 million, or 15.9%.
Creative Professional revenue increased $28.2 million, or 27.6%, to $130.6 million for the year ended December 31, 2017, as compared to $102.4 million for the year ended December 31, 2016, mainly due to a full year of revenue from Olapic and continued growth in sales of recurring licenses, web font revenue and digital ad revenue.
OEM revenue was $105.2 million and $101.1 million for the years ended December 31, 2017 and 2016, respectively, an increase of $4.1 million, or 4.1%. Revenue from our display imaging consumer electronic OEM customers increased and revenue from our printer imaging electronic OEM customers increased period over period, as we continued to convert customers to fixed fee contracts from royalty bearing contracts, partially offset by decreased revenue from our independent software vendor customers.
Cost of Revenue
Cost of revenue, excluding amortization of acquired technology, was $38.8 million for the year ended December 31, 2017, as compared to $32.9 million for the year ended December 31, 2016, an increase of $5.9 million, or 17.8%. The increase in cost of revenue, excluding amortization of acquired technology, is mainly due to increased revenue, period over period. In the year ended December 31, 2017, cost of revenue included a full year of costs from our Olapic business which we acquired on August 9, 2016 and a larger proportion of our Creative Professional revenue, as compared to the same period in 2016.
The portion of cost of revenue consisting of amortization of acquired technology was $3.5 million and $4.7 million in the years ended December 31, 2017 and 2016, respectively, a decrease of $1.1 million, or 24.4%, primarily due to an asset that became fully amortized in October 2016.
Gross profit was 82.1% and 81.5% of revenue in the years ended December 31, 2017 and 2016, respectively, an increase of 0.6 percentage points, mainly due to decreased amortization of acquired technology, net of variations in product mix as described above.
Marketing and Selling. Marketing and selling expense increased $26.9 million, or 41.7%, to $91.5 million for the year ended December 31, 2017, as compared to $64.6 million for the year ended December 31, 2016, primarily due to a full year of Olapic and investments in the Olapic business. Personnel and personnel related expenses increased $23.2 million period over period, mainly from our acquisition of Olapic and targeted hiring in our direct sales organization, increased variable compensation due to the increased revenue and severance expense associated with our restructuring action taken in the fall of 2017, primarily to refine our go-to-market approach for Olapic. Increased software and rent expense, primarily due to increased headcount, contributed $3.3 million to the overall increase in marketing and selling expense, for the year ended December 31, 2017, as compared to the same period in 2016.
Research and Development. Research and development expense increased $8.8 million, or 30.4%, to $37.7 million for the year ended December 31, 2017, as compared to $28.9 million for the year ended December 31, 2016. Personnel and personnel related expenses increased $7.9 million for the year ended December 31, 2017, as compared to the same period in 2016, mainly due to increased headcount in connection with our acquisition of Olapic and targeted hiring, net of a reduction for capitalized personnel costs for development projects and an increase in personnel costs classified as cost of sales for custom font development in 2017, as compared to the same period in 2016. Higher facilities related expenses contributed $0.9 million to the increase in research and development, period over period, a result of increased headcount and the addition of Olapic.
General and Administrative. General and administrative expense was $46.6 million for the year ended December 31, 2017, as compared to $42.6 million for the year ended December 31, 2016, an increase of $4.0 million, or 9.3%. Personnel and personnel related expenses increased $1.7 million in the year ended December 31, 2017, as compared to the same period in 2016, primarily as a result of key hiring and the addition of Olapic. Software and depreciation expense together increased $2.3 million, period over period, mainly due to the addition of Olapic.
Amortization of Other Intangible Assets. Amortization of other intangible assets was $4.1 million and $3.4 million in 2017 and 2016, an increase of $0.7 million, or 20.0%, respectively, primarily due to our acquisition of Olapic.
Interest Expense, Net
Interest expense, net of interest income, was $2.7 million and $1.2 million in 2017 and 2016, respectively, an increase of $1.5 million, mainly due to a full year of interest expense on our borrowings under our revolving line of credit for the acquisition of Olapic on August 9, 2016.
Loss on Foreign Exchange
Loss on foreign exchange increased $4.2 million to $4.8 million in 2017, as compared to $0.6 million in 2016. The loss in both periods was the result of currency fluctuations on our foreign denominated receivables and payables. In 2017, the loss was mainly attributed to the strengthening of the Euro, as compared to the U.S. dollar, on U.S. dollar denominated receivables held by our foreign subsidiaries.
Loss (Gain) on Derivatives
Loss (gain) on derivatives was a loss of $0.3 million and a gain of $0.5 thousand in 2017 and 2016, respectively, the net result of changes in the market value of our currency derivative contracts.
Provision for Income Taxes
Our effective tax rate was a benefit of 87.4% and a charge of 40.9% for the years ended December 31, 2017 and 2016, respectively. The 2017 effective tax rate included a benefit of 272.3% for tax rate changes due to The Act. Also in connection with The Act, the 2017 effective tax rate included a charge of 90.5% for valuation allowances provided on foreign tax credit carryforwards in 2017. The Act was enacted on December 22, 2017. The 2017 effective tax rate included a charge of 31.9% for non-deductible expenses recognized due to the Olapic acquisition and the acceleration of the contingent payments associated with the Swyft Media acquisition, compared to a charge of 7.0% in 2016. The 2017 effective tax rate included a charge of 16.4% for stock based compensation, as compared to a charge of 0.5% in 2016, primarily related to the change in accounting as a result of the adoption of ASU 2016-09, which requires that all tax effects of stock compensation be reflected as part of current period tax expense.
As of December 31, 2017, the total amount of unrecognized tax benefits was $7.1 million, as compared to a balance of $6.8 million in 2016, mainly due to increases as a result of positions taken in 2017. We classify potential interest and penalties as a component of tax expense. As of December 31, 2017 and 2016, we had $0.2 million and $0.2 million of accrued interest and penalties, respectively.
Year Ended December 31, 2016 as Compared to Year Ended December 31, 2015
The following table presents revenue for these two principal markets (in thousands):
Revenue was $203.4 million and $192.4 million for the years ended December 31, 2016 and 2015, respectively, an increase of $11.0 million, or 5.7%.
Creative Professional revenue increased $14.3 million, or 16.2%, to $102.4 million for the year ended December 31, 2016, as compared to $88.1 million for the year ended
December 31, 2015, primarily due to increases in web font revenue, recurring license web server applications and revenue from Olapic. Recurring revenue increased as a result of the release of digital ad impressions revenue and revenue from Olapic, period over period.
OEM revenue was $101.1 million and $104.3 million for the years ended December 31, 2016 and 2015, respectively, a decrease of $3.2 million, or 3.1%, mainly due to a decrease in royalty revenue. Royalty revenue from our printer and independent software vendor customers decreased due to lower volume of printer shipments and timing of custom project revenue, respectively. This decrease was partially offset by increased revenue from our display imaging consumer electronic OEM customers as a result of higher volume.
Cost of Revenue
Cost of revenue, excluding amortization of acquired technology, was $32.9 million for the year ended December 31, 2016, as compared to $30.3 million for the year ended December 31, 2015, an increase of $2.6 million, or 8.7%. The increase in cost of revenue in the year ended December 31, 2016, is a result of a higher proportion of Creative Professional revenue in our mix of total revenue which typically has a higher associated cost than OEM, partially offset by lower costs associated with our Creative Professional revenue with enterprise customers, as compared to the same period in 2015.
The portion of cost of revenue consisting of amortization of acquired technology was $4.7 million and $4.4 million in the years ended December 31, 2016 and 2015, respectively, an increase of $0.3 million, or 5.0%, due to our acquisition of Olapic.
Gross profit was 81.5% and 82.0% of revenue in the years ended December 31, 2016 and 2015, respectively. The decrease in gross profit in the year ended December 31, 2016, as compared to the same period in 2015, is a result of a higher proportion of Creative Professional revenue in our mix of total revenue which typically has a higher associated cost than OEM, partially offset by improved margins on our Creative Professional revenue with enterprise customers. Further, our Creative Professional revenue has grown both organically and from the acquisition of Olapic, while our OEM revenue has declined as described above. In 2016, Creative Professional revenue was 50.4% of total revenue, as compared to 45.8% of total revenue in 2015.
Marketing and Selling. Marketing and selling expense was $64.6 million and $57.3 million for the year ended December 31, 2016 and 2015, respectively, an increase of $7.3 million, or 12.7%, primarily due to personnel expenses. Personnel and personnel related expenses increased $7.8 million, mainly due to additional headcount from our acquisition of Olapic and other targeted hiring, additional compensation expense recognized on deferred compensation arrangements in connection with our acquisitions of Swyft and Olapic and restructuring actions. The increase was partially offset by a reduction in headcount due to a redeployment of certain employees at the beginning of 2016 to development related activities from our sales and marketing organization. Increased infrastructure expense due to increased headcount, contributed $0.7 million to the overall increase in marketing and selling expense, period over period. These increases were partially offset by a reduction in the use of outside consultants, resulting in a decrease of $1.1 million period over period.
Research and Development. Research and development expense increased $7.4 million, or 34.6%, to $28.9 million for the year ended December 31, 2016, as compared to $21.5 million for the year ended December 31, 2015 primarily due to personnel expenses. Personnel and personnel related expenses increased $5.7 million, mainly due to additional headcount from our acquisition of Olapic and the redeployment of certain former marketing and selling employees at the beginning of 2016, as compared to the same period in 2015. Headcount increased 73.4% over the prior year. External consulting and related software development increased $0.8 million period over period. Higher facilities related expenses contributed $0.4 million to the increase in research and development in the year ended December 31, 2016, as compared to the same period in 2015, a result of our acquisition of Olapic.
General and Administrative. General and administrative expense increased $9.3 million, or 27.8%, to $42.6 million for the year ended December 31, 2016, as compared to $33.3 million for the year ended December 31, 2015, primarily due to personnel expenses. Personnel and personnel related expenses increased $9.5 million in the 2016, as compared to the same period in 2015, mainly due to additional headcount from targeted hiring and our acquisition of Olapic. In the year ended December 31, 2015, we recognized a $3.8 million expense for deferred compensation arrangement in connection with the Amendment to the Swyft Media Merger Agreement. There was no similar item in the year ended December 31, 2016. Higher infrastructure expenses, primarily increased depreciation and software maintenance, together contributed $1.6 million primarily due to a full year of expense associated with our new ERP system. Increased legal, audit and rent expense together contributed $2.0 million to the overall increase, primarily due to our acquisition of Olapic in 2016, as compared to 2015.
Amortization of Other Intangible Assets. Amortization of other intangible assets was $3.4 million and $3.1 million in 2016 and 2015, an increase $0.3 million, or 8.8%, respectively, primarily due to our acquisition of Olapic.
Interest Expense, Net
Interest expense, net of interest income, was $1.2 million and $0.9 million in 2016 and 2015, respectively, an increase of $0.3 million, or 33.5%. The increase in interest expense in 2016 was primarily due to borrowings under our revolving line of credit. Total debt outstanding at December 31, 2016 was $105.0 million, which was drawn on our revolving credit facility in connection with our acquisition of Olapic, Inc. on August 9, 2016. Prior to August 9, 2016, there was no debt outstanding. In the year ended December 31, 2015, interest expense consisted mainly of unused line fees in connection with our credit facility.
Loss on Extinguishment of Debt
Loss on extinguishment of debt was $0.1 million in the year ended December 31, 2015, which was incurred in connection with the refinancing of our Credit Facility in September 2015. There was no similar item in 2016.
Loss on Foreign Exchange
Loss on foreign exchange decreased $0.6 million, or 55.6%, to $0.4 million in 2016, as compared to $1.0 million in 2015. The loss in both periods was the result of currency fluctuations on our foreign denominated receivables and payables.
Gain on Derivatives
Gain on derivatives was $0.5 million and $27 thousand in 2016 and 2015, respectively, the net result of changes in the market value of our currency derivative contracts.
Provision for Income Taxes
Our effective tax rate was 40.9% and 35.3% for the years ended December 31, 2016 and 2015, respectively. The 2016 effective tax rate included a charge of 7.0% for non-deductible expenses recognized due to the Olapic acquisition and the acceleration of the contingent payments associated with the Swyft Media acquisition, compared to a charge of 3.0% in 2015. The 2015 effective tax rate included a benefit of 3.2% for the reversal of reserves from the settlement of tax audits of our subsidiary in Japan and of our 2012 U.S. federal tax return, as well as the expiration of the statute of limitations on reserves related to the Companys 2011 tax returns, as compared to a benefit of 0.2% for the reversal of reserves in the 2016 effective tax rate. The 2016 effective tax rate included a charge of 3.2% for state and local income taxes, net of federal benefit, as compared to a charge of 1.0% in 2015. The research tax credit was a benefit of 1.9% in 2016, as compared to a benefit of 0.9% in 2015.
As of December 31, 2016, the total amount of unrecognized tax benefits was $6.8 million, as compared to a balance of $5.5 million in 2015, mainly due to increases as a result of positions taken in 2016. We classify potential interest and penalties as a component of tax expense. As of December 31, 2016 and 2015 we had $0.2 million and $0.1 million of accrued interest and penalties, respectively.
Recently Issued Accounting Pronouncements
Information concerning recently issued accounting pronouncements may be found in Note 2 to our consolidated financial statements included in this Annual Report on Form 10-K.
Liquidity and Capital Resources
Cash Flows for the Years Ended December 31, 2017, 2016 and 2015
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 one year from the issuance of these financial statements. At December 31, 2017, our principal sources of liquidity were cash and cash equivalents totaling $82.8 million and a $150.0 million revolving credit facility, of which $93.0 million is outstanding related to the acquisition of Olapic. On August 30, 2016, our board of directors approved a $25.0 million share purchase program, which provides for purchases through December 31, 2017. For the years ended December 31, 2017 and 2016, we used $7.0 million and $5.6 million in cash to purchase shares under the plan, respectively. In the year ended December 31, 2015, we used $18.2 million in cash to purchase shares in connection with our share repurchase program approved in October 2013 and completed in June 2015, after reaching the maximum cumulative spend. We also used $0.4 million in cash to purchase shares in excess of our previously approved share purchase program in 2015. In the year ended December 31, 2017, we used $18.8 million in cash for our quarterly dividend. Olapic has, and will continue to operate at a net loss in the near term. 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. In 2018, we anticipate a significant increase in payments to advisors associated with ongoing shareholder matters.
The following table presents our cash flows from operating activities, investing activities and financing activities for the periods presented (in thousands):
Variations in operating cash flows occur from time-to-time, because our enterprise customers make upfront payments on subscription revenue. These payments are required under the terms of our license agreements and can cause large fluctuations in accounts receivable and deferred revenue. The timing and extent of such payments may significantly impact our cash balances.
In 2017, we generated $32.9 million in cash from our operations. Net income after adjusting for depreciation and amortization, loss on retirement of fixed assets, amortization of deferred financing costs and accreted interest, stock based compensation, provision for doubtful accounts, deferred income taxes, and unrealized currency gain on foreign denominated intercompany generated $36.0 million in cash. Increases in accrued expenses and other liabilities, offset by increased prepaid expenses and decreased accounts payable, generated $4.9 million in cash mainly due to increased personnel in addition to the timing of payments. Accrued income taxes generated $1.3 million during 2017. Increased accounts receivable and decreased deferred revenue used $9.3 million in cash, which is mainly due to timing.
In 2016, we generated $40.7 million in cash from our operations. Net income after adjusting for depreciation and amortization, amortization of deferred financing costs and accreted interest, stock based compensation, excess tax benefit on stock options, provision for doubtful accounts, deferred income taxes, and unrealized currency gain on foreign denominated intercompany generated $46.1 million in cash. In connection with the Olapic acquisition, we used $9.0 million in cash to fund an escrow account to be used for the payments due in 2018 and 2019 under the Agreement. In addition, $0.4 million was generated from the release of funds from the Swyft Media escrow account. Increases in accounts payable, accrued expenses and other liabilities generated $12.1 million in cash mainly due to increased headcount in addition to the timing of payments. Accrued income taxes used $1.9 million during 2016. Increased accounts receivable and prepaid expenses, net of increased deferred revenue used $6.8 million in cash, which is mainly due to timing.
In 2015, we generated $53.4 million in cash from our operations. Net income after adjusting for depreciation and amortization, loss on retirement of fixed assets, loss on debt
extinguishment, amortization of deferred financing costs and accreted interest, adjustment to contingent consideration, stock based compensation, excess tax benefit on stock options, provision for doubtful accounts, deferred income taxes, and unrealized currency (loss) gain on foreign denominated intercompany generated $58.5 million in cash. In connection with the Amendment to the Swyft Media Merger Agreement executed in November 2015, we used $6.2 million in cash to fund an escrow account to be used for the payments due in 2018 under the Agreement. As the balance may only be utilized for such payments, it has been classified as restricted cash in our balance sheet as of December 31, 2015 and included in operating and financing activities. Increases in accrued expenses and other liabilities, and accounts payable, combined with a decrease in prepaid expenses and other assets generated $2.0 million, which is mainly due to the timing of payments including a higher dividend accrual. Accrued income taxes generated $1.9 million during 2015. Increased accounts receivable and deferred revenue used $2.8 million in cash, which is mainly due to the timing of a couple large deals.
During 2017, we used $7.0 million in investing activities for the purchase of property and equipment. During 2016, we used $120.8 million in investing activities for the purchase of $2.5 million of property and equipment and $118.3 million for acquisitions. During 2015, we used $22.9 million in investing activities for the purchase of $8.6 million of property and equipment and $14.3 million for acquisitions.
Cash used in financing activities in 2017 was $35.7 million. We received cash from the exercises of stock options of $2.0 million. We paid cash dividends of $18.8 million, and paid $12.0 million on our outstanding revolving line of credit. We also purchased $7.0 million in treasury stock during 2017.
Cash provided by financing activities in 2016 was $85.2 million. Cash borrowed from our revolving Credit Facility for the acquisition of Olapic generated $110.0 million, of which we have since paid back $5.0 million. We received cash from exercises of stock options of $2.8 million and excess tax benefit on stock options provided $0.6 million. We paid shareholder dividends of $17.5 million and used $5.6 million to purchase treasury stock in 2016.
Cash used in financing activities in 2015 was $32.6 million. We received cash from exercises of stock options of $8.2 million and excess tax benefit on stock options provided $1.8 million. We paid shareholder dividends of $15.1 million, contingent consideration of $5.7 million, and used $18.6 million to purchase treasury stock in 2015. We used $3.1 million of restricted cash related to the Swyft Media founder-shareholder contingent consideration.
Dividends are declared at the discretion of the Companys Board of Directors and dependent on actual cash from operations, the Companys financial condition and capital requirements and any other factors the Companys Board of Directors may consider relevant. We anticipate this to be a recurring quarterly dividend with future payments and record dates subject to board approval. On October 26, 2017, the Board of Directors approved a $0.113 per share, quarterly cash dividend on our outstanding common stock. The record date was January 2, 2018 and the dividend was paid to shareholders on January 22, 2018. On February 14, 2018, our Board of Directors approved a $0.116 per share quarterly cash
dividend on our outstanding common stock. The record date is set for April 2, 2018 and the dividend is payable to shareholders of record on April 20, 2018.
On September 15, 2015, the Company entered into a new credit agreement (the New Credit Agreement) by and among the Company, the Companys subsidiary, Monotype Imaging Inc., any financial institution that becomes a Lender (as defined therein) and Silicon Valley Bank, as agent which provides for a five-year $150.0 million secured revolving credit facility (the Credit Facility). The Credit Facility permits the Company to request that the Lenders, at their election, increase the secured credit facility to a maximum of $200.0 million. The Credit Facility is available to the Company on a revolving basis through September 15, 2020. Repayment of any amounts borrowed are not required until maturity of the Credit Facility. However, the Company may repay any amounts borrowed at any time, without premium or penalty. The Company had $93.0 million and $105.0 million outstanding under the Credit Facility at December 31, 2017 and 2016, respectively. Available borrowings under the Credit Facility have been reduced by approximately $0.5 million for one standby letter of credit issued in connection with a facility lease agreement, leaving $56.5 million and $44.5 million available for borrowings at December 31, 2017 and 2016, respectively.
Borrowings under the Credit Facility bear interest through September 15, 2020 at a variable rate not less than zero based upon, at the Companys option, either LIBOR or the higher of (i) the prime rate as published in the Wall Street Journal, and (ii) 0.5% plus the overnight federal funds rate, plus in each case, an applicable margin. The applicable margin for LIBOR loans, based on the applicable leverage ratio, is 1.25%, 1.50% or 1.75% per annum, and the applicable margin for base rate loans, based on the applicable leverage ratio, is either 0.25%, 0.50% or 0.75%% per annum. At December 31, 2017 our rate, inclusive of applicable margins, was 3.1% for LIBOR. The Company is required to pay a commitment fee, based on the applicable leverage ratio, equal to 0.20%, 0.25% or 0.30% per annum on the undrawn portion available under the revolving credit facility and variable per annum fees in respect of outstanding letters of credit. In connection with the New Credit Agreement, the Company incurred closing and legal fees of approximately $1.0 million in 2015, which have been accounted for as deferred financing costs and will be amortized to interest expense over the term of the New Credit Agreement. In addition, $0.2 million of unamortized deferred financing costs associated with the pro-rata share of the prior loan syndicate lenders that did not participate in the new facility were written off and charged to other expense in the third quarter of 2015.
In addition to other covenants, the New Credit Agreement 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. The New Credit Agreement also contains events of default, and affirmative covenants, including financial maintenance covenants which include (i) a maximum ratio of consolidated total debt to consolidated adjusted EBITDA of 3.00 to 1.00, and (ii) a minimum consolidated fixed charge coverage ratio of 1.25 to 1.00. Adjusted EBITDA, under the Credit Facility, is defined as consolidated net income (or loss), plus net interest expense, income taxes, depreciation and amortization, and stock based compensation expense, plus acquisition expenses not to exceed $2.0 million on a trailing twelve month basis, plus restructuring, issuance costs, cash non-operating costs and other expenses or losses minus cash non-operating gains and other non-cash gains; provided however that the aggregate of all cash non-operating expense shall not exceed $250 thousand
and all such fees, costs and expenses shall not exceed $1.5 million on a trailing twelve months basis. As of December 31, 2017, the maximum leverage ratio permitted was 3.00:1.00 and our leverage ratio was 2.17:1.00 and the minimum fixed charge coverage ratio was 1.25:1.00 and our fixed charge ratio was 3.83:1.00. Failure to comply with these covenants, or the occurrence of an event of default, could permit the Lenders under the New Credit Agreement to declare all amounts borrowed under the New Credit Agreement, together with accrued interest and fees, to be immediately due and payable. In addition, the Credit Facility is secured by a lien on substantially all of the Companys and its domestic subsidiaries tangible and intangible property by a pledge of all of the equity interests of the Companys direct and indirect domestic subsidiaries and by a pledge by the Companys domestic subsidiaries of 65% of the equity of their direct foreign subsidiaries, subject to limited exceptions.
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):
The Credit Facility also contains 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 Credit Facility as of December 31, 2017 and 2016.
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 net income, which is the most directly comparable GAAP operating financial measure, to net adjusted EBITDA as used by management (in thousands):
In our quarterly earnings press releases and conference calls, in addition to Adjusted EBITDA and net adjusted EBITDA as discussed above, we discuss a key measure that is not calculated according to GAAP. This non-GAAP measure is non-GAAP earnings per diluted share, which is defined as earnings per diluted share before amortization of acquired intangible assets and stock based compensation expenses. We use non-GAAP earnings per diluted share as one of our principal indicators of the operating performance of our business. We use non-GAAP earnings per diluted share in internal forecasts, supplementing the financial results and forecasts reported to our board of directors and evaluating short-term and long-term operating trends in our operations. We believe that non-GAAP earnings per diluted share 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 non-GAAP earnings per diluted share may be valuable indicators of our operating performance.
The following table presents a reconciliation from earnings per diluted share, which is the most directly comparable GAAP measure, to non-GAAP earnings per diluted share as used by management:
Other Liquidity Matters
The following summarizes our contractual obligations at December 31, 2017 and the effect of such obligations on liquidity and cash flow in future years (in thousands):
We may be required to make cash outlays related to our unrecognized tax benefits. However, due to the uncertainty of the timing of future cash flows associated with our unrecognized tax benefits, we are unable to make reasonably reliable estimates of the period of cash settlement, if any, with the respective taxing authorities. Accordingly, unrecognized tax benefits of $7.1 million as of December 31, 2017 have been excluded from the contractual obligations table above. For further information on unrecognized tax benefits, see Note 11 to our consolidated financial statements included in this Annual Report on Form 10-K under Item 8.
In addition to the above, we have a pension obligation under the German defined benefit pension plan. The total projected benefit obligation is $6.3 million and details regarding this plan are located in Note 10 to our consolidated financial statement included in this Annual Report on Form 10-K under Item 8.
Legal proceedings and disputes
Details on recent legal matters can be found in Notes 15 and 17 to our consolidated financial statements included in this Annual Report on Form 10-K under Item 8.
Off-Balance Sheet Arrangements
As of December 31, 2017 and 2016, we did not have any material relationships with unconsolidated entities, often referred to as special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. Other than our operating leases for office space and computer equipment, and derivative financial instruments discussed in Quantitative and Qualitative Disclosures about Market Risk, we do not engage in off-balance sheet financing arrangements.
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 bonds and municipal securities, with maturities less than 90 days at the date of purchase. Deposits of cash held outside the United States totaled approximately $24.3 million and $16.4 million at December 31, 2017 and 2016, 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 December 31, 2017 and 2016, there were no customers that individually accounted for 10% or more 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. Our Creative Professional business consists of a higher volume of lower dollar value transactions. Accordingly, as the percent of Creative Professional revenue increases in relation to total revenue, we expect the average time to collect our accounts receivables, and our overall accounts receivables balances, to increase.
For the years ended December 31, 2017, 2016 and 2015, no customer accounted for more than 10% of our total revenue. For the quarters ended December 2017, 2016 and 2015, no customer individually accounted for more than 10% of our total revenue.
Interest Rate Risk
Our exposure to market risk associated with changes in interest rates relates primarily to our long-term debt. At December 31, 2017 and 2016, the Company had borrowings under our revolving Credit Facility of $93.0 million and $105.0 million, respectively. The interest rate on our Credit Facility fluctuates with either the prime rate or the LIBOR interest rate and at December 31, 2017 our rate was 3.1% for LIBOR. A 10% increase in the rate would have increased our interest expense by $0.3 million.
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 or historical rates, as appropriate. Revenue and expenses of these subsidiaries are translated at the average monthly exchange rates. The resulting translation adjustments as calculated from the translation of the foreign subsidiaries to U.S. dollars are recorded as a separate component of comprehensive income. For the years ended December 31, 2017, 2016 and 2015, sales by our subsidiaries located outside North America, primarily EMEA and Japan, comprised 56.9%, 58.3% and 45.5%, respectively, of our total revenue. An effect of a 10% weakening of the British pound sterling, the Euro, Japanese yen and Argentine peso, relative to the U.S. dollar, would have decreased our revenues by $9.5 million, decreased expenses by $10.6 million and increased operating income by $1.1 million for the year ended December 31, 2017. The sensitivity analysis assumes that all currencies move in the same direction at the same time and the ratio of non-U.S. dollar denominated revenue and expenses to U.S. dollar denominated revenue and expenses does not change from current levels.
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 customers functional currency is received and converted into U.S. dollars, we can incur realized gains and losses. We also incur foreign currency exchange gains and losses on certain intercompany assets and liabilities denominated in foreign currencies. We are currently utilizing 30-day forward contracts to
mitigate our exposure on 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 December 31, 2017, we had one 30-day forward contract to sell 2.5 million British pound sterling and to purchase $3.4 million that together had an immaterial fair value. At December 31, 2016, we had one 30-day forward contract to sell 2.8 million British pound sterling and to purchase $3.4 million that together had an immaterial fair value. There were no outstanding forward contracts at December 31, 2015.
MONOTYPE IMAGING HOLDINGS INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
The Board of Directors and Stockholders of
Monotype Imaging Holdings Inc.
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of Monotype Imaging Holdings Inc. (the Company) as of December 31, 2017 and 2016, the related consolidated statements of income, comprehensive income, stockholders equity and cash flows for each of the three years in the period ended December 31, 2017, and the related notes and the financial statement schedule listed in the Index at Item 15(a) (collectively referred to as the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2017 and 2016, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2017, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Companys internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework), and our report dated February 27, 2018 expressed an unqualified opinion thereon.
Basis for Opinion
These financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on the Companys financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ Ernst & Young LLP
We have served as the Companys auditor since 2005.
February 27, 2018
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share data)
The accompanying notes are an integral part of these consolidated financial statements.
CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except share and per share data)
The accompanying notes are an integral part of these consolidated financial statements.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
The accompanying notes are an integral part of these consolidated financial statements.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY
(in thousands, except share and per share data)
MONOTYPE IMAGING HOLDINGS INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY (Continued)
(in thousands, except share and per share data)