Shutterstock, Inc. (SSTK) Q3 2018 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen, and welcome to the Q3 2018 Shutterstock Inc Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time. [Operator Instructions] I would now like to introduce your host for today's conference, Ms. Amy Behrman, Senior Director of Corporate Development, Strategy and Investor Relations. You may begin.

Thank you, operator. Good morning, everyone and thank you for joining us for Shutterstock's third quarter 2018 earnings call. Joining me today is Jon Oringer, our Founder, Chief Executive Officer and Chairman; and Steven Berns, our Chief Operating Officer and Chief Financial Officer. During this call, management may make forward-looking statements that are subject to risk and uncertainty, including predictions, expectations, estimates and other information. These include statements referring to long-term effects of our investments in our business, the future success and financial impact of new and existing product offerings. Our future growth and profitability, our long-term strategy, our growth potential, potential future results of efforts to reduce our expense footprint and implementation of large-scale business solutions, and our 2018 guidance. Our actual results may differ materially from the results predicted, and reported results should not be considered as an indication of future performance. Please refer to today's press release and the reports and documents we file from time-to-time with the U.S. Securities and Exchange Commission, including the section entitled Risk Factor in the company's annual report on Form 10-K for the year ended December 31, 2017, and quarterly report on Form 10-Q for the quarter ended June 30, 2018, and September 30, 2018 for discussions of important risk factors that could cause actual results to differ materially from those discussed in any forward-looking statements we may make on this call. On this call, we will refer to adjusted EBITDA, adjusted net income, revenue growth on a constant currency basis, including and excluding Webdam, revenue per download on a constant currency basis and free cash flow, all of which are non-GAAP financial measures. You can find a description of these item along with a reconciliation to the most directly comparable GAAP financial measures in today's earnings release, which is posted on the Investor Relations section of our website. We believe that the use of these measures in conjunction with GAAP financial measures allows investors to consider our operating results on the same basis used by management. This provides them with important additional insights about the company's overall business and operating performance and enhances comparability in assessing our financial reporting. However, these non-GAAP financial measures should not be considered as a substitute for or superior to financial information prepared in accordance with GAAP. Lastly, as a reminder, we sold Webdam in February of 2018, and therefore, Webdam did not contribute to our third quarter 2018 operating results. However, Webdam was included in our 2017 results and therefore, some of our commentary today will specifically state that we are excluding the results of Webdam, meaning that we are excluding it from the third quarter of 2017 to provide a comparable basis to the third quarter of 2018. And with that, I would like to turn the call over to Jon.

Thanks, Amy, and thank you, everyone, for joining us for today's Shutterstock, for today Shutterstock's Third Quarter 2018 Earnings Call. During the third quarter, we continued to execute on our strategic goal of being the go-to global platform for our customers' creative and editorial needs, empowering them with compelling content, innovative tools and valuable services, our focus on cost management and operational efficiencies yielding results and improving margins and increased free cash flow generation. At the same time, we are also investing considerable time and resources to upgrading our technology infrastructure to enhance the customer experience. Revenue increased 7.5% on a reported basis. Excluding the impact of Webdam and the impact of foreign currency movements, third quarter revenue increased 11.3%. Adjusted EBITDA grew 8.1%, driven primarily by the impact of increased revenue and the benefits of our continued cost management efforts. Our e-commerce channel grew 8.5%, driven by the success of our image products, however, our revenue growth, specifically related to footage, was negatively impacted by some issues being encountered during the implementation of certain technology initiatives in the quarter. We have taken actions to correct and stabilize our technology environment and believe the impact to revenue was temporary and that we are well positioned for improved growth. Across e-commerce channel, we continue to pursue marketing activities with a strong ROI and are focused on increasing conversion and customer lifetime value. We continue to optimize pricing and packaging options. We also introduced UI and UX improvements on our footage site, and we are continuing to optimize that user experience. Our enterprise channel delivered top line growth of 14.1%, as compared to the third quarter of 2017, driven by the APAC and EMEA regions. While the growth in the quarter was below our expectations, we have and continued to invest in our operational infrastructure to increase the efficiency and productivity of the team. We are encouraged by our year-to-date results, revenue has increased 26% versus the same period in 2017, and revenue has increased 27% on a trailing 12-month basis. Moving back to the third quarter. The enterprise channel represented 41% of our total revenue in the quarter, as compared to 39% in the same quarter of 2017. We continue to invest in a variety of sales and marketing initiatives to increase customer conversion and consumption. And getting into more detail on our specific product areas, the custom product continues to expand and diversify our product offering for customers by offering unique concept tailored for their brands. Our platform solutions offering, which represents our API integrations, continue to deliver steady growth and increase the breadth of partners, integrating Shutterstock's assets and the workflow tools. Our editorial offering continued to gain traction and provided coverage of over 1,400 entertainment and sports events throughout the quarter. The team is also focused on building the functionality and support of the offering of our editorial content on our e-commerce platform, which is made available for license this month. In addition to the main content library of approximately 221 million images and approximately 12 million video clips, Shutterstock's comprehensive editorial collection contains over 40 million images and publishes on average more than 70,000 new images per month. We also introduced new shape composition and date search filters, which allow customers to find specific content quickly and efficiently. Lastly, we acquired the Allan Davidson's Archives, which includes approximately 500,000 images focused on British celebrities and society dating from the mid-1930s to the present. We continue to be excited about the opportunity for our editorial offering on both the product and the content side. As of September 30, 2018, the Shutterstock had -- there were 550,000 contributors on the Shutterstock's platform, an increase of approximately 75% since the third quarter of 2017, an increase of nearly 16% since the second quarter of 2018. This increase in contributor sign-ups is attributable to process improvements made to the contributor sign-up flow and product improvements to our contributor platform and upload tools. We will continue to optimize our contributor platform with the goal of being the first place contributors think about to monetize their content. While our revenue and adjusted EBITDA performance in the third quarter did not meet our expectations, we believe that our accomplishments to date and the work we continue to do position us for increased growth and profitability, and we believe that we are well positioned to execute on our operational strategic plans for the balance of 2018 and beyond. And with that, I'll turn the call over to Steven, for a more detailed financial review.

Thanks, Jon, and thank you, everyone, for joining us today. Before I discuss our performance, as always, I want to let you know that we posted a brief information deck on our website that contains supporting materials for today's call. Moving right into the financial performance. Revenue on a reported basis grew 7.5%, as compared to the third quarter of 2017, and as Jon said, adjusted EBITDA grew 8.1%. Two items, which impacted our year-over-year growth -- revenue growth rates in the third quarter were that given that we sold Webdam in February of 2018, there was no revenue related to Webdam in the third quarter of this year, and the other impact is that of foreign currency fluctuations. So excluding the impact of foreign currency movements, revenue growth was approximately 8% in the third quarter, as compared to 2017. Excluding the impact of Webdam from the 2017 third quarter, revenue growth in the third quarter of 2018 was approximately 10.7%. And excluding both FX movements and Webdam, revenue grew 11.3% in the third quarter of 2018. Regarding some key metrics that we discuss each quarter, on a year-over-year basis, our customer base grew by 5.1% to nearly 1.9 million customers, paid downloads grew by 4.9% to 43.9 million, and revenue per download grew by 5.3% on a reported basis and 5.7% on a constant currency basis. Our image library expanded by 42% to approximately 221 million images, and our video library increased by 44% to approximately 12 million clips. As Jon mentioned earlier, revenue generated by our e-commerce channel improved 8.5% to $88.7 million, as compared to the prior year third quarter. And our enterprise channel grew by 14.1% to $62.9 million in the quarter. GAAP net income in the quarter was $7.4 million or $0.21 per diluted share, an increase from net income of $5 million or $0.14 per diluted share in 2017, representing a 49% increase year-over-year. Adjusted net income was $13.4 million or $0.38 per diluted share for the third quarter of 2018 as compared to $10.9 million or $0.31 per diluted share in the third quarter of 2017, that's an increase of 23% per diluted share. Adjusted EBITDA for the quarter was $25.1 million, which compares to $23.2 million in the same period a year ago. Consistent with prior periods, in the third quarter of 2018, approximately 66% of our revenues were from customers outside the United States. Of that 66% amount, about half was derived from customers in Europe and the balance was from Asia Pacific, Latin America, Canada, and the Middle East. Operating expenses, excluding stock compensation increased 8% versus the third quarter of 2017, driven primarily by investments we're making in both our infrastructure and our smaller but high growth, high potential businesses. However, as compared to the second quarter of 2018, these expenses decreased 4% driven by our focus on cost management throughout the P&L. Contributor royalty expense was approximately 27.3% of revenue, which is essentially unchanged from our recent historical experience. Before I go into some of our major expense categories, I'd like to reiterate that we have taken and continue to take actions to reduce the growth rate of our expenses. We are seeing results in our improving margins through 2018. Expense management is an ongoing effort that we believe will continue to yield improved results in the fourth quarter of this year and beyond. As I discussed the expense categories, my comments exclude stock-based compensation expense and refer to variances between the third quarter of 2018 versus the third quarter of last year. Sales and marketing expense increased 16%, generally this category of spend is split equally between marketing spending and the cost of our enterprise sales organization. As always, we work to improve the return on investment on this spend. Sales and marketing expense was 27% of revenue in the third quarter of this year as compared to 25% in the third quarter, last year. Product development cost increased 11% versus the third quarter last year primarily due to higher personnel and consulting costs related to rebuilding more expansive customer platform. As a percentage of revenue, product development costs were flat at 8% from the quarter versus the prior year period. And general and administrative expenses decreased by 6% from the second quarter of 2018, and decreased 18% from the third quarter of last year. As a percentage of revenue, G&A expenses were 13% as compared with, to 17% in the third quarter of last year. The decreases in G&A this quarter show the results of cost management measures that have been taken throughout the year and we'll continue to work to improve our margins throughout the remainder of 2018 and well into 2019 and beyond. We have a tax benefit of approximately $500,000 in the third quarter of 2018 and a net expense of $700,000 for the three months ended September 30, 2017. Income tax expense decreased by $1.2 million for the three months as compared to the same period last year and we expect that the full-year effective rate will now be in the low 20% range, which is lower than our prior 2018 guidance of the mid-20% range. During the 9 months ended September 30, 2018, our net cash taxes paid were approximately $400,000, compared to $4.1 million in the first 9 months of 2017. The effective tax rate is based on the provisions of the Tax Cuts and Jobs Act and our best estimate at this point of the impact of the relevant provisions of the act based on available information and guidance received to date. We will continue to monitor additional information and implementation guidance as and when it becomes available. Taking a look at deferred revenue. On December 31, 2017, the deferred revenue balance was $137.7 million, and that excludes deferred revenues relating to Webdam and it's adjusted for the adoption of the new revenue recognition rules, which went into effect on January 1. So once again, on 12/31/17, that balance was $137.7 million. At the end of the third quarter of 2018, deferred revenue balance was $141.4 million, of which approximately 40% relates to our e-commerce channel and 60% to our enterprise channel. This represents an approximately 3% increase in deferred revenue on a year-to-date basis. Moving to cash flows and the balance sheet. Our net cash flows from operations was $30.5 million, a decrease of $611,000 from the third quarter of 2017, but an increase of $13.6 million from the second quarter of this year. Free cash flow was $22.4 million, an increase of $4.2 million from the third quarter of 2017. Free cash flow includes cash payments for capital expenditures and content purchases. This change was primarily driven by lower capital expenditures and lower cash used to acquire content, partially offset by a decrease in cash provided by operations. In the third quarter of 2018, capital expenditures were $6.5 million, a decrease from the $11.9 million of CapEx in the third quarter of 2017. At the end of the quarter, we had approximately $206 million of cash and cash equivalents, and as a reminder, on August 29 of this year, we paid a special nonrecurring dividend of $3 per share, totaling $104.9 million. Our liquidity strategy continues to be to maintain a strong cash position that enables us to fund operations, while also providing us with the flexibility to consider operational and strategic growth opportunities that we are not already pursuing. As we have done historically, we will continue to evaluate the appropriate use of cash generated in our business to maximize returns for shareholders. As disclosed in our Form 10-Q for the third quarter of 2018, which was filed earlier this morning, we identified a material weakness in our internal controls over revenue recognition of sales transactions related to certain enterprise license arrangements outside of our standard product catalog. Specifically, our internal controls and procedures did not provide assurance that revenues related to such products was recorded in the proper periods. The identified deficiencies resulted in immaterial errors recorded immaterial errors in recorded revenue and did not result in a material misstatement of our consolidated financial statements or disclosures for all historical periods. We are in the process of identifying and implementing a remediation plan to address the control deficiencies that led to the material weakness. Moving to our financial guidance. For the full year 2018, excluding the impact of Webdam, we are tightening the guidance range with respect to revenue, adjusted EBITDA and income from operations and have improved guidance for non-cash equity-based compensation, capital expenditures and our effective tax rate. The guidance is as follows: we expect revenue of between $625 million and $630 million for the year, which represents growth of 15% to 15.9%, and that's a tightening of the range from the previous guidance of $625 million to $635 million. Adjusted EBITDA of approximately $105 million, representing growth of 19.3% and that's a tightening of the range from the prior guidance of $105 million to $110 million. The adjusted EBITDA guidance excludes the gain we recognized on the sale of Webdam. Income from operations of between approximately $30 million to $32 million, and that's a tightening of the range from the prior guidance of $30 million to $35 million. Non-cash equity-based compensation expense of approximately $25 million, and that's down from $28 million. Capital expenditures including capitalized labor of approximately $42 million, which is a reduction of $6 million from the $48 million prior guidance. And lastly, as I mentioned earlier, the effective tax rate we now expect is in the low 20% range, which has improved slightly from our prior guidance of the low to mid-20s percents. We appreciate your time today and your interest in Shutterstock. And now Jon and I will be happy to answer any questions you may have. Catherine, please prompt the participants for questions.

Thank you. [Operator Instructions] And our first question comes from Youssef Squali with SunTrust. Your line is open.

Great. Good morning. And thank you very much for taking the questions. I have a couple. Jon, you mentioned the issue, the implementation of technology initiatives issue that you had during the quarter. I was wondering if you can flush that out a little bit? And more importantly, maybe Steven, you can -- if you can quantify the impact of that on revenue growth this quarter will be super helpful. I'm assuming that hit the enterprise business, but I'm not sure, because the enterprise business shows a pretty strong decel from 30% plus to 14% this quarter. And then just stepping back a little bit, historically, you guys have talked about the business sustaining double-digit revenue growth for the next few years, considering the performance this quarter and even guidance for Q4, is that still realistic? And if so, how do you reaccelerate growth? And on the margin side, you guys have also talked about 20%, mid-20s, south of long-term EBITDA margin, is that still achievable? Thank you.

Yes. I'll start with -- thanks for the question. I'll start with the technology issue that we ran into. It relates to our data center to AWS move and a couple of issues around that, one of which was a manhole fire in Queens, which affected some of our technology stack for a certain amount of time. Another was a software issue. We believe, we've fixed both. We've installed redundant lines and we've also made sure that whatever the issue was should not come back again. It -- as it -- on your question of whether it affected both e-commerce and enterprise, yes, it affected both.

And in any way you can quantify it?

Yes. As it relates to being able to quantify something like that, it's not really something that we can estimate with any degree of precision. We certainly know that the user experience is impacted. We also know that, that is not something that we expect to happen going forward. So I would not, I would not quantify it, we believe that our customers recognize that things will happen from time-to-time and we will work to make sure that they are few and far between as ever. So our point of view is that, while the quarter was impacted, it was not, it's not a number that we can answer with any degree of precision or even a range at this point. What I would say with regard to our long-term guidance, and kind of the fourth quarter of 2018 as well as both revenue and EBITDA as you say for the long term. I think it's important to look at the longer, the rolling 12-month period and the mid-20% growth that we've had on the top line and not look at the third quarter as a proxy for everything that comes here and after. And as well as from a profitability standpoint, we started to see the impact of some of the actions we've taken, we have lots of continuing actions to reduce the growth rate in costs and do believe that the EBITDA margins in the mid-20s are achievable in the medium term.

Okay. So if I can just follow up with one question, maybe on the competition. Jon, maybe you can just update us on, just what you see on the competitive landscape. Adobe stocks growth seems to be, have accelerated in the last quarter or so relative to what they've done in the last few quarters, and Getty seems to be back with the family looking to refinance the debt et cetera. Is this leading to any increase in the competitive intensity in the space that you're seeing or that you expect? Thank you.

We don't see any difference in the competitive environment, any difference in how competitive the environment is compared to previous quarters or years. This has been a competitive space from the start, it's been a competitive space for 15 years. There's been some consolidation along the way and competitors have changed, but we still strive to be that go-to marketplace for both the buyer and the seller. And we see that plenty of times. We are the first for both.

Okay, great. Thank you, both.

Thank you. Our next question comes from Brian Fitzgerald with Jefferies. Your line is open.

Thanks guys. A couple of quick ones, and some of my follow-ups to Youssef's questions. On the enterprise side, was there anything to call out in specific geographic regions that also contributed there? Second question is, we saw Vimeo move into stock footage space. You've always been nimble at maybe testing and optimizing elasticities, it looks like their economics may favor the contributor. Are you seeing anything specifically with Vimeo on the stock footage side? And then my last one is around deployment of capital. You have over $200 million of cash on the balance sheet, no debt, last quarter you executed your special dividend and it looks like you didn't do any of the buyback. Can you talk a little bit about what you think of the best uses of the capital right now? Thanks guys.

Yes. I'll start with Vimeo. I mean, this goes back to the competitive question earlier. There have been companies of all sizes that enter this space, there are companies of all sizes that have exited the space as well. We continue to compete, and we don't see any major changes on the contributor or the buyer side and that goes, especially for the Vimeo entry into the space.

As it relates to the enterprise growth in the quarter, as it relates to the various regions, we did not see any particular, if you would, variation among the regions. All the regions experienced weakness relative to our growth in the prior quarter over the second quarter of 2017. Clearly, we, as Jon indicated in his comments and as I have stated, there's a number of actions that we have been taking and continuing to take to make sure that, that stabilizes. And our recent experience since the end of quarter is evidence of the fact that, that is performing better. As it relates to the deployment of capital, I think, it's, as you said, we did pay a dividend of about $105 million. We did not buy shares in the period, and we don't have a repurchase plan, was not on autopilot for taking into account. We had other potential distributions of capital. What we've said is, our target cap positioned has been in the $200 million to $250 million range and so we are comfortable where we are at this point. And every quarter, if not more frequently, we evaluate what the opportunities are and we'll continue to do so, but we don't have any plans to announce today in terms of future distributions if any.

Our next question comes from Ralph Schackart with William Blair. Your line is open.

Steven, just one follow-up on your last response. I think, you had mentioned that you've taken a number of actions on enterprise business and that the recent experiences suggest that it's improved the business. Just curious if you could, sort of, give a little bit more color what specific actions you've taken? And then should we interpret the comments of recent experience to mean that the business has returned back to, sort of, the normal growth that we've seen in prior quarters?

Yes, so, I mean, clearly, we're at the 30th of October and so we've seen, we see the month of October to this point, and my comments are reflective of our, of what we see to date for October. I think, as it relates to the actions we take, as Jon mentioned, the site stability issues that we had in the third quarter, we believe, we have corrected and continue to make sure that the performance improvement of our site on a global basis. Now that we're in AWS as well as implementing other technology improvements in, prior to the third quarter, but also in the third quarter, we are starting to see significant benefit from user experience. And we believe that, that will translate into revenue growth -- increased revenue growth going forward.

Thank you. [Operator Instructions] Our last question comes from Lloyd Walmsley with Deutsche Bank.

Hey. Wanted to just ask another one on the enterprise business. It looks like it sequentially even was down quarter-over-quarter. We haven't really seen that and that seems like something more pronounced than short-term technical issues. So is there anything you can point to more specifically that's been weighing on that business? And then you've mentioned pricing and packaging optimization, were there any changes in price around the enterprise business? Or just can you give us a sense of what the pricing and packaging optimization was in the quarter?

So as we have talked about, Lloyd, in the past, our -- some of the implementation we've done on our new tech stack enables us to have a more robust testing environment where we are able to be far more iterative in what we offer customers, what we see that -- what works, what doesn't work and so that enables us to be more nimble. We have not seen, if you would, anything, there's nothing in the third quarter that I would specifically point to other than, I'd say, our execution in the quarter was not as good as we would have expected. I think the growth in the third quarter of 2017 relative to the prior quarter on a sequential basis, in 2017, was strong. We had a relatively good summer, but as we said, as we got into August and September, we did experience some technical issues, which, we think, had an impact on our business. I'm not attributing a 100 -- all of that to that, but I do think, it's important that you consider not just the 3 months of -- and I said this is the second quarter -- it's the second quarter results and I'll say it again, when we do well and when we do less well in the quarter, it is not necessarily indicative of a trend. And I think a more reasonable trend is on a rolling 12-month basis and we're up 27% on a rolling 12-month basis. And so things will have ebbs and flows. And we're focused onto the key fundamentals that we put in place to drive both revenue growth and profitability. And we believe that we've continued to do that in the third quarter despite the fact that the financial results in the third quarter don't reflect the full impact of the actions we've taken.

Okay. And then just on the pricing and packaging optimization. Anything more you can share, you're moving prices up or down as part of that?

It's really just when we think about our various products and when we think about portfolio product, customers may want a mix of products rather than just a single product. So we -- rather than just purchasing images, we have a situation where they might purchase images, editorial, footage, music as a package. We do that often times with enterprise customers who have a variety of either video or production capabilities and businesses and we're able and we adapted to the, either the sector of the economy that they participate in or their specific needs. And so that's what we're talking about where we're able to be more nimble than we had previously operated at.

Okay. And then just last one. It look like gross margins came in a little bit lower. And if our math is right, at least royalty has ticked up a hair as a percent of revenue, anything you need to call out there. Is it mix? Is it, Yeah, anything, anything worth explaining there?

Yeah. There was an increase in the amortization of capitalized labor that flows through cost of revenue as a result of the prior period's expenditures that went into cap-labor.

Got it. Thank you.

Thank you. And I'm sure, no further questions at this time. I'd like to turn the call back to Mr. Steven Berns, Chief Operating Officer and Chief Financial Officer for any closing remarks.

Thank you very much. We appreciate your time today and look forward to speaking with you soon. Thank you.

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