Shutterstock Inc (SSTK) 2017 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Q3 2017 Shutterstock Inc.

Earnings Conference Call.

(Operator Instructions) As a reminder, this conference call may be recorded.

I would now like to introduce your host for today's conference, Michael Mestrandrea.

Please go ahead.

Thank you, operator.

Good morning, everyone, and thank you for joining us for Shutterstock's Third Quarter 2017 Earnings Call.

Joining me today is Jon Oringer, our Founder, Chief Executive Officer and Chairman; Steven Berns, our Chief Operating Officer and 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 relating to expansion of our addressable market, the growth of customer base, success of new and existing product offerings, growth and predictability of our revenue, adjusted EBITDA, equity-based compensation, foreign currency rates, taxes, and capital expenditures.

Our actual results may differ materially from the results predicted.

The reported results should not be considered as an indication of future performance.

Please refer to today's press release, the reports and documents we file from time to time with the U.S. Securities and Exchange Commission, including the section entitled risk factors in the company's annual report on the Form 10-K on December 31, 2016, for discussion of important risk factors that cause actual results to differ materially from those discussed in any forward-looking statements that we may make on this call.

On this call, we refer to adjusted EBITDA, adjusted EBITDA growth, adjusted EBITDA margin, adjusted net income, each of these metrics on a consistent (sic) [constant] currency basis, revenue growth on a constant currency basis, free cash flow, all of which are non-GAAP financial measures.

You will find a description of these items, along with the reconciliation of most directly comparable GAAP financial measures in today's earnings release from our Form 8-K, which are posted on our Investor Relations website.

We believe that the uses of the measures, in conjunction with GAAP financial measures, provide an important additional insight for investors about the performance of the company's overall business and operating performance.

It enhances comparability for investors in assessing our financial reporting.

However, these non-GAAP financial measures should not be considered as a substitute for financial information prepared in accordance with GAAP.

And with that, I'll turn the call over to Jon.

Thanks, Mike, and thanks, everyone, for joining us today for Shutterstock's Third Quarter 2017 Earnings Call.

We continue to make progress in our business.

As we noted last quarter, we are seeing positive operational momentum as a result of our new technology platform and operating structure.

We are pleased with the improvement in our top line performance in the third quarter, though our margins continue to be affected by the investments we are making in our business, which will have a long-term positive impact.

In the third quarter of 2017, on a constant currency and year-over-year basis, revenue grew 14% and adjusted EBITDA increased 1%.

In addition, on a year-over-year basis during the third quarter of 2017, our customer base grew by 11% to nearly 1.8 million customers.

Paid downloads increased by 2% to $41.9 million.

We grew revenue per download by 10% on a constant currency basis.

We expanded our image library by 52% to over 155 million images, and our video library increased by 54% to more than 8 million clips.

We continue to take deliberate actions to transition from a stock image marketplace to a broader platform that provides individuals and enterprises with the various content types and tools needed to collaboratively design, build and distribute creative projects.

Over the past few years, we have been making investments in our business that are enabling us to address a larger opportunity that we believe will drive shareholder value over the long-term.

Our technology platform, which as you know, has been undergoing an upgrade over the last several quarters is showing positive results from our investments.

We're seeing a better speed of innovation, which is allowing us to get our products and services to the market quicker and more efficiently.

Operationally, we are now organized to align more deliberately with our customers, which means we are able to focus on our product, engineering and marketing efforts according to customer needs and demands and respond more quickly to market dynamics.

Let me tell you that I see this happening every day across the organization at all levels.

This past July, we completed our acquisition of Flashstock, now rebranded as Shutterstock Custom.

We serve enterprise marketers seeking on-brand custom content across channels.

All of these actions are leading to positive momentum in our business.

In our e-commerce image business, we're seeing solid customer growth and our focus continues to be on offering the right pricing and packaging for our customer base and optimizing our customer acquisition funnel.

As we noted last quarter, earlier this year, we launched 2 smaller subscription packages, which are driving improvements in mix and retention.

We've also been able to ramp up A/B testing significantly in our e-commerce business since getting on to our new technology platform.

Importantly, while doing this, we have also improved the efficiency of our sales and marketing spending, resulting in lower cost per acquisition in the quarter.

We continue to upgrade our product offering.

We are utilizing our search tools and machine-learning capabilities to deliver the best experience for customers globally.

Earlier this month, we launched a beta version of a new tool called Composition Aware Search that transforms the way users can search for images using computer vision.

With this tool, our customers can find objects that exist in specific parts of an image.

For marketers, searching for an image with copy space or for an object or person in a specific location in an image becomes easy.

We believe we are just scratching the surface when it comes to machine learning and machine vision.

Turning to our enterprise business, we continue to build our geographic presence and expand usage of video, music and editorial.

We are getting very strong feedback from our customers who are increasingly making purchases across content types.

Revenue generated by our enterprise business grew 29% year-over-year and represented approximately 35% of our total revenue base in the third quarter compared to 31% in the third quarter of last year.

Within our motion business, we have begun a process of simplifying our pricing structure for video and continue to make progress in building out the portfolio of products on RocketStock, which provide video packs in the 3 leading video effects elements and high-quality after effects template, including lower thirds and title sequences.

In editorial, we covered approximately 1,900 events in the third quarter, including fashion week, and over 700 sporting events, resulting in the 38% year-over-year increase in image licenses.

Moving to Shutterstock Customs.

The integration of Flashstock into Shutterstock is going well.

In September, we rebranded the offering of Shutterstock Custom, and we are very pleased with the feedback from customers.

We continue to believe Custom is a large long-term opportunity for us and that we're well positioned to significantly add to the customer and contributor community that Custom has today.

We believe that the global custom content creation category is a $7 billion addressable market alone, giving us tremendous opportunity with new and existing customers.

In summary, this was a solid quarter for our business.

We're attracting new customers, responding quickly to their challenging and changing needs, delivering new and innovative products and solutions and have built a modern, technological and operational infrastructure that is well positioned to drive profitable growth.

We're excited about our momentum.

And with that, I'll turn the call over to Steven, who will provide a more detailed overview of our financial performance.

Thanks, Jon, and thank you, everyone, for joining us today.

Before I discuss our third quarter performance, I want to let you know that we posted a brief presentation deck as well as other items on our website that contain supporting materials for today's call.

As Jon has highlighted, Shutterstock continued to execute against our strategic vision throughout the third quarter, translating into revenue growth on a reported basis of 15%, and an adjusted EBITDA margin of 16%.

As Jon mentioned, we completed the acquisition of Flashstock in July, which is rebranded now as Shutterstock Custom.

As previously mentioned, Shutterstock Custom will have a minimal impact on our financial results in 2017, but we believe it will be a significant growth engine in years to come.

On a constant currency basis, as compared to the prior year third quarter, revenue growth was 14% and adjusted EBITDA margin was 16%.

This past quarter, our customer base expanded 11% to 1.8 million customers.

As compared to the prior year third quarter, we saw revenue per download increase 11% on a reported basis or 10% on a constant currency basis, driven by the continued growth in our enterprise and motion businesses, as well as a shift within our e-commerce business toward our smaller subscription plans, which are sold at higher price per image rates than our traditional larger subscriptions.

Revenues generated by our e-commerce business improved 6% as compared to the prior year third quarter, as we are continuing to see positive results from the changes in product mix of our subscription business.

Our enterprise business delivered 29% year-over-year growth to $49.3 million.

International expansion and localization continues to be a core part of our long-term growth strategy.

In the third quarter of 2017, of the approximately 60% of revenues from customers outside the United States, approximately half was derived from customers in Europe, with the balance from Asia Pacific and Latin America.

Shifting to the cost side of the business.

For the third quarter of 2017, operating expenses increased 21%, versus the third quarter of 2016, driven primarily by investments we are making in both our infrastructure and our smaller, but high-growth high-potential businesses along with increased sales and marketing spending year-over-year.

Contributor royalty payments were approximately 27% of revenue in the third quarter, which is unchanged from the second quarter of 2017 and slightly lower than the third quarter of 2016.

I will now discuss some of the major expense categories, and for each category discussed, my comments and the numbers I will reference excludes short-term – excludes stock-based compensation expense.

I'd like to point out that while we have positive results in revenue growth this quarter, we believe our G&A expenses are at a level that should not be considered the new normal.

We are taking actions to reduce these costs, which we expect will result in margin expansion in 2018.

Our sales and marketing expense increased 9% versus the third quarter a year ago.

The spend is split roughly equally between performance marketing and the cost of our sales organization.

Overall, our return on investment on this spend is healthy and remains consistent with our historical pattern.

Additionally, as we continue to build our enterprise sales engine, we've been able to keep sales rep productivity and ramp rates consistent with our historical levels.

Product development cost increased 15% in the third quarter of 2017 versus the third quarter last year, primarily due to higher personnel and consulting costs, related to -- relating to building a more expansive platform for our customers.

General and administrative expenses increased by 61% for the third quarter versus the same period a year ago, driven primarily by higher personnel costs and consulting expenses related to implementations of several large-scale business solutions, which we believe will enhance the organization's operational efficiency.

GAAP net income for the quarter was $5 million or $0.14 per diluted share.

Adjusted net income was $10.9 million or $0.31 per share for the third quarter of 2017.

Overall, our revenue growth in the third quarter, along with increased operating expenses, translated into adjusted EBITDA of $23.2 million, which compares to adjusted EBITDA of $23 million in the same period a year ago.

Moving to cash flows and the balance sheet.

We had another strong quarter.

We generated $31.1 million of cash from operations, free cash flow, which includes cash outflows for capital expenditures and content purchases.

In addition, cash flow for the 9 months ended 9/30/17 benefited from lower income taxes paid of $4.1 million compared to $16.3 million in the 9-month period ended 9/30/2016.

Also, as previously reported in July 2017, we used approximately $50 million of cash to acquire Flashstock.

At the end of the third quarter, we had approximately $235 million in cash and liquid investments.

Total deferred revenue grew 24% year-over-year to $146.4 million at the end of the third quarter of 2017, of which approximately 44% relates to our e-commerce business and 50% to our enterprise business with 6% of the deferred revenue balance due to other businesses.

Turning to the remainder of the year.

We remain encouraged by the momentum across our businesses, and we are leaving full year guidance unchanged with the exception of capital expenditures and capital labor -- capitalized labor.

We expect fourth quarter capital expenditures to be approximately $15 million.

So based on this estimate, we now expect our full year capital expenditure guidance to be $55 million, of which capitalized labor is expected to be $35 million for 2017.

Further, given the trends we have been seeing in the business to date in the fourth quarter, we believe our full year 2017 revenues will be at the higher end of our guidance range of $535 million to $545 million.

However, as we believe we still have higher levels of investment in the fourth quarter of this year, we expect our operating income and adjusted EBITDA guidance to be in the low to mid-point range of that previously issued guidance.

Our financial guidance is detailed in today's earnings release.

So for any questions you may have, please refer to it for historical guidance.

We appreciate your time today, and now Jon and I will be happy to answer any questions you may have.

Charlotte, can you please prompt the participants for questions.

(Operator Instructions) Our first question comes from the line of Lloyd Walmsley from Deutsche Bank.

I'm going to ask two if I can.

First, it looks like you're pushing the new Custom product pretty hard, Adweek specifically.

Can you just talk about the customer reception for this?

And give us a sense for what kind of revenue contribution that made in the quarter?

And how we should think about it going forward?

And then, second, it looks like you're taking up the guidance on capitalized R&D quite a bit.

So wondering if you can talk about what is driving that.

And then, is any of that focused on kind of the fourth quarter, and then coming out as we get into next year and kind of a onetime-ish basis?

Or is that just increasing investment that's going to continue?

I'll start out talking about Custom and then I'll hand it over to Steven on your other question.

Custom is really exciting for us.

So ever since we started this company back in 2003, stock photography has been a really important business need.

But over and over, they've asked us if there was any way that we could provide more customized images with their products in those images.

We always knew we were either going to figure out a way to build into the space or purchase a company and merge our way or acquire our way into the space.

And when we met Grant at Flashstock, we realized that he had the right product, the right technology and a customer base that aligned perfectly with ours.

So what we have today is that product that we accelerated right to something that we can integrate into our business very fast.

And we get to take the 30,000 enterprise customers that we have and bring them right into that product and the 300,000 very active contributors that we've known, some of which for over a decade into that product as well.

So we can offer a lot to that business line and get the Custom product in our enterprise customers' hands as well.

So to the questions with regard to the contribution from Custom in the quarter, what we've said is for the full year basis, it's a small amount that's de minimis.

And therefore, what we've -- we haven't changed our numbers, and it's not material to the year.

So we'll include it as part of our enterprise business as we go into 2000 -- as we are now and into 2018 and beyond, but it is once again, not material to the period.

As it relates to the capitalized labor, we've had a number of areas where we've been spending on features, functionality, re-platforming of our technology base, all of which have resulted in both internal and external resources being devoted to that.

A significant portion of that is -- has a life beyond -- a useful life beyond the current period.

And therefore, under GAAP, it requires capitalization.

We amortized that over a 3-year period.

As we look forward, there has been a lot of external costs that we have had in terms of external labor regarding project -- moved really specific projects and specific deliverables.

We are -- We'll be reducing that, and as we reduce that, we would expect that, as I indicated in my comments, that the level of G&A spend, which is combined with both period costs as well as the amortization of the capitalized labor but that number that you see in this period is not the new normal.

So what we see in the fourth quarter is kind of a finishing up of many areas, but not a level that we expect as we go forward.

We don't have any specific comments with regards to 2018 guidance other than to say that as we look at 2018, we feel confident that our expectations of improved operating and EBITDA margins is a reasonable expectation.

Okay.

And if I can just follow up on the contribution, maybe you can just help us understand, would enterprise revenue have accelerated without any contribution from the Flashstock business?

Is that something you can help us with?

Yes.

Flashstock had no impact on the enterprise revenue percentage change in the quarter that would have been significant.

So while it was -- obviously, they had some revenue.

It was not material to the period.

And keep in mind that because of the way in which you account for revenue of an acquired entity that it comes through at a relatively low margin for the deferred revenue that was on their balance sheet at the time of the acquisition.

So especially in this period, it's not material.

Our next question comes from the line of Brent Thill from Jefferies.

This is Alex Giaimo on for Brent.

Maybe just a follow-on to the previous question, if you can just discuss further the trends you're seeing in the enterprise business.

It looks like the growth there re-accelerated nicely from 2Q, which is a positive.

You touched on it a bit in the opening comments so maybe just color on client feedback and the momentum you're seeing there.

And how you expect this to trend moving forward?

So as it relates to the trends in enterprise, we've talked about that, obviously, this is not a sprint, it's a marathon.

And we're certainly -- while the second quarter was not what we would consider to be a good proxy for the future.

We are pleased with where we are in the third quarter.

We still believe that as it relates to both the share of wallet that we have from existing customers as well as the total number of customers that there are significant opportunities here around the world.

So as we think about adding Custom to, as Jon indicated, to that platform that many customers use.

And as customers are now taking in-house, a lot of activities that may have been done externally before, that creates a significant opportunity given that our platform has both the content and the tools that enable for many of the activities that they perform, whether those be just pushing out a content -- developing, producing content and then pushing that out to various websites and other digital platforms, that can all be done on the Shutterstock platform.

And so it creates a workflow environment that is substantially improved versus the marketplace environment that we've previously had.

So we continue to look at the enterprise customer and our offering and enhance it, and would expect to do so going forward.

So we've had very positive client feedback.

I think the question that came up before as it relates to our presence at Adweek, I think is just a reflection of the fact that we feel very positive about the Custom product and its meaningfulness to our enterprise customers.

So as we look forward, all positive trends.

But once again, we're not taking anything for granted and continue to keep our head downs -- our heads down and pound away at it.

Our next question comes from the line of Ralph Schackart from William Blair.

Two questions, if I could.

First, on the guidance.

Typically, Q4 would display a seasonal pattern of a sequential uptick over Q3, at least going back to past couple of years.

So just curious if there was any revenue pull forward in the Q3 that you would expect in Q4 this year.

And then second, in the prepared remarks, you talked about a lower customer acquisition costs.

Just curious, maybe sort of the one or 2 primary drivers of that.

And then, would that be sort of the new operating norm you would expect going forward?

So as it relates to the sequential guidance -- the sequential quarters, we expect the seasonality to be within the normal ranges.

There's nothing significant that we expect in the fourth quarter relative to our historical pattern of fourth quarter over third quarter.

And so, one reason, our guidance on revenue is at the high end of the range is because our performance in the third quarter when we look at the 9 months and then the fourth quarter, it's just from -- and a trend basis for where we are in the month of October, we feel comfortable with updating that statement.

As it relates to the cost of acquiring customers, we've seen continued improvement in our marketing efficiency.

And therefore, the cost to acquire has been favorable.

As we look forward, we see lots of opportunity to increase our marketing spend in various ways and in various marketplaces, and we'll continue to do that.

We expect to do so efficiently, but I wouldn't say that the cost per acquisition is something that is easily predicted because the competitiveness in the marketplace as it relates to SEM spend and other activities varies from period-to-period.

But we certainly -- that's why we're always looking for efficiencies because we want to be able to maintain a level of spend that allows us to be flexible as it relates to pricing in the marketplace for the various marketing and content types we go after.

(Operator Instructions) Our next question comes from the line of Youssef Squali from SunTrust.

Two questions if I may.

One, Jon, just big picture.

Can you speak to, again, the growth in the overall segment whether you think you're gaining share, losing share?

And any updates to the competitive dynamics that have evolved in the space in the last 12 months or so?

And then, Steven, your tax rate was substantially lower?

Can you maybe speak to that and your kind of what you'd expect that to be in Q4?

And lastly, SBC also came in a little bit better.

What's your guidance for the rest of the year?

Yes, I'll start.

So big picture, growth in segment.

There's a lot of opportunity left in the space.

Just to remind you, of all the businesses we're in, e-commerce, images, where we sell images over the e-commerce channel, our enterprise business, which continues to grow, our editorial products, which we're just starting to see some traction with and we'll continue to get the assets that people need and cover the events when it comes to sports, the entertainment images that people need and all the media content, we'll continue to grow into that world.

Our digital asset management product that we acquired through WebDAM, we're going to continue to find places to integrate that into our different products and services.

Our motion business, audio and video, we are the first into the space and definitely have innovated on that product more than our competitors.

I believe there's a lot of upside there, too.

And now, with Custom, a brand-new multibillion-dollar market that we get to cross-sell and upsell our current customers into and it's growing well on its own even before we started to do that.

If you combine all of this and think about the fact that today we touch about 1.8 million customers and if you look at small businesses alone, easily above 15 billion.

Around the world, there's a lot of upside here.

There's a lot of businesses for us to continue to sell into and continue building all 6 of these lines of business.

If you take it further from there, which we plan to do and we're doing currently, you take workflow, you take tools and you tie all of the 6 lines of business together, and you start to create a platform and that's where this business is going.

I can talk a lot about our business, if you talk -- if you want some information on the competitive area.

I think it's best left for what you can find out there, but that's what we're focused on today.

As it relates to the tax rate question, as I've indicated for the past couple of years, we've been focused on reducing our cash taxes effectively that has, obviously, an impact on our rate.

And we've done so with good planning and good process here.

There was a discrete tax benefit in the third quarter from the U.S. R&D tax credit, as well as other activities that are some are a couple of discrete items that are detailed in our footnote in our 10-Q that was filed this morning.

We feel very positive about where we are.

We'll continue to be -- I don't want to say -- we'll continue to be very mindful of our cash taxes.

We had $12 million year-over-year cash tax savings.

And so that is a significant level.

We did not realize how quickly we would achieve some of these benefits and so we're pleased with our ability to do so.

We -- our cash -- or I should say, our tax rate for the full year, we still expect, I'd say, in the mid-30s based on discrete items that could possibly be slightly lower.

But we'll continue to, once again, to be focused on minimizing our cash taxes and given our global footprint, our expanding customer base outside the United States and the various operations we have, all of that makes it possible for us to have this lower rate.

So once again, really pleased with our position to date.

But we'll continue to be very mindful of the opportunities ahead of us.

And on the stock-based comp, I think initially, earlier in the year, you had guided to about $30 million.

I think you are tracking much lower than that, I think you're tracking around $20 million for the first 9 months?

Yes.

I mean, that number, we -- I would say is a function of a number of items in terms of our compensation policies and being mindful of delusion.

And so when -- what we've done is we've just been consistent in terms, I'd say, over the past year or 2, in terms of how we think about the overall dilution and make sure that while we continue to focus on paying our employees competitively that we're also mindful of the impact of equity grants.

And so, we look at this – and I'd say, we certainly would expect that it's going to be in the mid-20s at this point in time.

But it's not -- the best proxy for the fourth quarter expense is the third quarter expense.

There's nothing that specifically we expect to happen in the fourth quarter.

Our next question comes from the line of Kip Paulson from Cantor Fitzgerald.

Just a couple from me.

So given the acceleration in e-commerce and enterprise, how did this growth pick up throughout the quarter?

Was this pretty much linear?

Or was it more back-end-quarter weighted?

And ultimately, where do you think enterprise revenue contribution can get to over time?

And then, the second question would be, when do you expect investment growth to slow somewhat relative to your revenue growth?

So as it relates to the inter-quarter activity, July and September tend to be the stronger months relative to the third quarter, that was no different in 2017 as we've seen in prior periods.

And we continue to see -- we saw a good June in -- despite the results of the second quarter not being where we would have wanted them.

July really followed a good June.

And then, August just the nature of holidays and vacations and -- on the clients’ side and the agency side tends to be less activity.

And so, strength in both of those months and August, once again, continued to be on a relative basis, a good period for us.

As it relates to the enterprise -- I should say, I'll just jump to the question on -- what was your last question on?

Oh, on gross, on our expense gross versus revenue growth.

I talked about that as it relates to -- we expect growth in the margins to be greater in -- to be better in 2018.

So we're not -- while we do expect some continued expenses as I talked about earlier in the call, as it relates to capitalized labor and amortization of previously capitalized labor due to external costs of implementation on projects on various parts of our platform.

As we get into 2018, we are very mindful of that and expect expansion of our operating margins.

At this time, I'm not showing any further questions and would like to turn the call back over to Steven Berns for any closing remarks.

We appreciate everybody's time today.

Thanks again for your interest in Shutterstock.

We'll talk to you next quarter.

Ladies and gentlemen, thank you for participating in today's conference.

This does conclude the program, and you may all disconnect.

Everyone, have a great day.