Shutterstock, Inc.

Ladies and gentlemen, thank you for standing by, and welcome to the Q3 2020 Shutterstock, Inc. Earnings Conference Call. At this time, all participants are in a listen-only mode, and after the speaker's presentation, there will be a question-and-answer session. To ask a question during the session, you'll need to press star 1 on your telephone. Please be advised that today's conference is being recorded. If you require any further assistance, please press star 0. I'd now like to hand the conference over to Chris Hsu, Vice President, Investor Relations and Corporate Development. Please go ahead, sir.

Thank you, James. And good morning, everyone. Thank you for joining us today for Shutterstock's third quarter 2020 earnings call. Joining me today is Stan Pawlowski, our Chief Executive Officer, and Jared Yates, our Chief Financial Officer. Please note that some of the information you hear during our discussion today will consist of forward-looking statements, including without limitations, impacted COVID-19 on our business, the long-term effects of investments in our business, the future success and financial impact of new and existing product offerings, our future growth, margins, and profitability, our long-term strategy, and our performance targets. Actual results or trends could differ materially from our forecast. For more information, please refer to today's press release and the reports we file with the SEC from time to time, including the risk factors discussed in our most recently filed 10-Q and and our annual 10-K for discussions of important risk factors that could cause results to differ materially from any forward-looking statements we may make on our call. We'll be discussing certain non-GAAP financial measures today, including adjusted EBITDA and adjusted EBITDA margin, adjusted net income, revenue growth, including by distribution channel on a constant currency basis, billings, and free cash flow. Reconciliations of these non-GAAP measures to the most directly comparable GAAP measures can be found in the financial tables included with today's press release and in our 10Q, which are posted on the investor relations section of our website. Finally, please refer to the brief information that we posted on our website that contains supporting materials for today's call. And now at this time, I'll turn the call over to Stan.

Thanks, Chris. Good morning, everyone, and thank you for joining Shutterstock's third quarter earnings call. This quarter, Shutterstock returned to year-on-year revenue growth. with revenue of $165 million, representing growth of 4 percent from Q3 of last year, or 3 percent on a constant currency basis. We saw year-on-year revenue growth across all regions, especially in North America, which was up 6 percent, which represented roughly half of the total growth. Europe and rest of the world were each up 3 percent. Revenue growth across these regions, particularly in North America, was driven by our smaller subscription products. To continue to grow revenue, we are very focused on innovating on our product offering. For example, in response to the success of our smaller image subscriptions, we rolled out smaller footage subscriptions with allotments as low as five licenses per month for $99 per month. Through our low-cost subscription model, we've made our professional quality video content accessible to a broader audience, including prosumers and the DIY marketer audience. To help this audience ease into working with video content and to expedite the editing process, we include with the subscription a set of free clips that are pre-edited by our in-house creatives so users can save time on editing and focus on their storytelling. In addition, in October, we launched our first monthly premium music sub also with an allotment of five licenses for $64.95 per month. On an annualized basis, we believe that these new subscription products will be accretive to our average revenue per customer. The product innovation we are driving is leading to strong results against the subscription KPIs we introduced last quarter and is attracting a whole new audience for Shutterstock. While our subscription metrics were exceptionally strong this quarter and we're pleased with the results, we do not believe the space of growth will continue each and every quarter. Jared will go into more detail on our KPI metrics in a few minutes. Now turning our attention from product innovation to overall strategy, we continue to make progress against Shutterstock's three strategic focus areas that I've outlined previously. Workflow innovation, fresh and relevant content, and data and insights to drive performance. Today, I'd like to spend some time particularly on workflow innovation in the enterprise channel. On the workflow innovation front in the third quarter, we began to establish the groundwork for a broader vision of driving inspiration and customer value. In the third quarter, we started to work with a number of beta customers to test and refine our enterprise customer experience. Our new enterprise experience introduces self-serve capabilities including bulk actions, such as licensing and downloads, and improved access to multi-asset workflows and discoverability. We also completed the beta launch of our collaborative workspaces application. Workspaces, which is a core piece of our strategy to drive higher content utility, will allow us to improve customers' creative workflow process by enabling on-platform collaborative discovery and ideation across teams from small and medium businesses to enterprise. In addition to innovating with workflow in the enterprise, we recently brought to market two exciting new products with the launch of editorial video and Shutterstock Studios. At launch, editorial video will have more than 250,000 user-generated live and archival video clips across news, entertainment, sports, and fashion, which is highly complementary to our editorial image catalog containing over 50 million images. Shutterstock Studios enables us to go beyond stock content to provide custom project services to address unique customer needs. Now moving on from our strategic initiatives to discussing progress against our margin objectives, EBITDA in the Q3 was 47 million, which represents a 29% adjusted EBITDA margin up from 14% last year and up from 23% in Q2. Our strong EBITDA margins reflect our efforts at improving the efficiency of our content, technology, and marketing efforts. We are, however, going to continue to invest for growth and do anticipate some margin compression over the next several quarters while we make requisite investments in our business. More specifically, as we look towards the rest of 2020 and 2021, we have a number of areas in which we plan to invest for growth. We continue to invest aggressively to drive growth in our platform solutions offering, which includes headcount expansion in both sales and technology. We continue to see platform solutions as a highly attractive area to redeploy capital given, as laid out last quarter, the opportunity to expand to new market segments and new customers, secure higher usage and engagement, and drive higher customer and revenue retention. We also continue to invest in people, not just in expanding the platform solutions team, but also in sales, marketing, product, and technology. I was also thrilled to announce earlier in the month that Sarah Birmingham joined Shutterstock as Chief Human Resources Officer. She brings a wealth of experience in building and optimizing high-performing organizations in a fast-changing environment. Before turning the call over to Jared to discuss our financial, I wanted to thank the Shutterstock team for our impressive performance this quarter. And now I'll turn the call over to Jared.

Thank you, Stan, and good morning, everyone. In the third quarter, Shutterstock realized a return to revenue growth earlier than we previously expected, driven by the success of our subscription offerings and continued momentum in our enterprise revenue channel. Q3 revenues grew 4% year-on-year, or 3% on a constant currency basis. Growth was led by our e-commerce channel, which grew 7%, representing the fastest growth rate over the past year and a material uptick from last quarter. Our enterprise channel also improved materially, from down 6% last quarter to down 1% this quarter, or an improvement of 5%. In our enterprise channel, it's clear that the changes we have implemented are now having a positive impact. By reinvigorating our sales organization, innovating our suite of product offerings, and making further platform investments in our API, we're starting to see improvements in both bookings and deferred revenue. we saw a $6.4 million sequential increase in deferred revenues, which is indicative of the progress we're making. We believe we are still tracking for the enterprise channel to return to recognize revenue growth in the early part of 2021. From a geographic perspective, we saw a return to year-on-year revenue growth and revenue acceleration this quarter across all regions, with particular strength in North America, which was up 6% to $59 million. Europe grew 3% to $53 million, and the rest of the world, including Asia, also grew 3% to $53 million. Gross margins were 63.5%, up approximately 350 basis points from the first quarter. While the gross margins were strong, I would note for investors that part of the gross margin improvement is short-term in nature and driven by the reduction in utilization and paid downloads of 6.2%, which is partially due to the pandemic. As utilization normalizes, we expect our gross margins to decline from these levels, and investors should not expect this level of gross margin on a go-forward basis. Sales and marketing expense was 22% of revenue, as compared to 29% in the third quarter of 2019. Consistent with the second quarter, we've adhered to tight metrics on our marketing ROI and become more efficient at customer acquisition. As expected, there was a sequential increase in sales and marketing from Q2 to Q3, consistent with our plan for accelerating marketing spend in the back half of the year on branding our new subscription products and targeted performance marketing. Product development costs were 6% of revenue, down from 9% in the third quarter of 2019. In product development, we're seeing reductions in software costs, employee costs, and third-party contractor costs. We expect to continue to invest in developing new products and internal tools and enhance the functionality of our existing products and technologies. So I would expect to see increases in product development costs going forward. G&A expenses were 17% of revenue, down from 18% of revenue in the third quarter of 2019. G&A expenses in the third quarter included $3.1 million of expense associated with performance-based stock awards, where we anticipate the performance criteria now being met for those awards. Absent this expense, G&A would have approximated 15% of revenue, which is more in line with our G&A in the second quarter. We are continuing to exert discipline with respect to vendor cost reductions and accelerating efforts towards process automation. We believe these decisions will enable us to create long-term operating leverage in G&A as our business scales. Adjusted EBITDA margins increased to 29 percent compared to 14 percent in the third quarter of 2019. This was an exceptional quarter from a margin perspective. However, please note that with the investments we are making in products and platform and the expectation of higher utilization in the quarters to come, this will pressure margins in the quarters to come. Gap net income was 22.6 million or 62 cents per diluted share. Adjusted net income was $29.3 million, and adjusted diluted earnings per share was $0.80 per share as compared to $10.3 million, or $0.29 per diluted share in the third quarter of 2019. On August 14th, we completed a $125 million marketed offering of common stock and achieved several investor relations objectives for Shutterstock, including broadening our shareholder base, increasing our public float, and significantly expanding the universe of equity research analyst coverage. We are pleased to welcome our new institutional investors and research analysts, and look forward to working with them closely as we execute on our long-term vision for creating shareholder value at Shutterstock. Turning to our balance sheet and cash flows. At the end of the quarter, we had $383 million of cash, up from $311 million at June 30, 2020. The quarterly increase in cash of $72 million includes $64 million of operating cash flows, in addition to $23 million of net proceeds from the stock offering, partially offset by $7 million of CapEx and content acquisitions, and the $6 million quarterly cash dividend paid in September. Our deferred revenue balance increased to $144.7 million from $138.2 million at June 30, 2020, for an increase of $6.4 million. The change in deferred revenue is due to both our e-commerce and enterprise businesses, and this increases a positive development as a result of getting back to bookings growth in prior periods. Turning to our key operating metrics, they were a particular bright spot for Shutterstock during the quarter. Subscribers increased by 39% to 255,000 from 184,000 at the end of Q3 2019. Subscriber revenue increased by 12% to 67.6 million from 60.1 million in the third quarter of 2019. And subscriber revenue as a percentage of total revenue increased to 41%. Average revenue per customer increased 0.3% year-over-year to $328. While we are truly pleased with these trends and are aggressively investing in the subscription product innovation pipeline, as Stan discussed, we do not believe this pace of growth in subscription will continue each and every quarter. Paid downloads continue to be soft, and we're down 6% to $43.4 million. partially due to a reduction in activity and utilization related to the pandemic. This resulted in revenue per download increasing by 39 cents to $3.79 per download. Our image library expanded by 18% to over 350 million images, and our video library increased by 25% to over 20 million clips. In terms of capital allocation, We will pay out our next quarterly dividend of 17 cents per share on December 16th, 2020. As previously stated, we plan to grow the dividend in line with earnings growth and plan to revisit the quarterly dividend with our fourth quarter earnings release. With respect to our M&A strategy, we're seeing a number of opportunities for smaller bolt-ons of key talent and technology, as well as medium-sized acquisitions, and are optimistic we'll have some announcements before the end of the year on that front. While we expect to provide full year 2021 earnings guidance with our fourth quarter results, we wanted to provide investors color on what to expect through the fourth quarter. Firstly, we expect revenue growth to be consistent with the third quarter, assuming no material change in demand and utilization patterns due to the pandemic. While we are pleased with the positive momentum we experienced in the quarter and the return to growth, Our return to revenue growth is encouraging, but until our industry gets back to the previously forecasted 5% to 7% TAM growth, we'll continue to be cautious in evaluating our growth prospects for 2021. From an EBITDA margin perspective, we expect Q4 EBITDA margins to be approximately 20% as we continue reinvesting some of the year-to-date margin upside we've experienced. Expense increases for the fourth quarter will be focused in sales and marketing and And we also expect increased utilization to pressure gross margins, both in Q4 as well as 2021 as compared to current levels. We are pleased as a management team with our Q3 results, both in terms of the return to revenue growth combined with the exceptional margins. As stated previously, we plan to continue to reinvest some of that margin upside we've experienced to best position Shutterstock for growth in the years to come. Thank you for joining us today. We very much appreciate your time. Operator, we'd now like to open the line for any questions.

At this time, I'd like to remind everyone, in order to ask a question, please press star, followed by the number one on your telephone keypad, and we'll pause for a moment while we compile the Q&A roster. And our first question comes from the line of Yusuf Squali from Twist Securities. Go ahead, please. Your line is open.

Great. Thank you very much. Good morning, guys, and congrats. Pretty impressive cost containment story there. First question is around just the trends you're seeing post Q3, I guess in October, just the sustainability of the improvement that you're seeing both on the e-commerce and the enterprise. And on the cost side, that was – a big surprise. Maybe can you unpack the gross margin improvement a little bit? I think you talked about lower utilization just because of the pandemic, but there are a whole slew of other things that you guys are doing in terms of rev share to the contributors and other things. Jared, maybe you can just help us kind of parse out the different impacts from different components and Your Q4 guidance of 20% gross margin seems to be pretty – I'm sorry, EBITDA, not gross margin, of 20% seems to be substantially below what you just reported. So, again, maybe if you can just go over the puts and take there would be super helpful. Thanks.

Hey, Yusuf. It's Stan. Thanks so much. I'll touch on the sort of Q4 piece and then let Jared talk about the gross margins. So just real quick, in terms of the momentum heading into Q4, we continue to see the momentum that we saw in Q3 sort of into Q4, and hence the guidance that we're giving around the performance for the quarter, which is continued strength in e-commerce and continued improved momentum in enterprises. I'll let Jared touch on the gross margin piece.

Sure. And, Yusef, I think we feel good about the gross margins. We feel good about the trajectory of gross margins. And there's a number of reasons why the gross margins are trending in the right direction. I think last quarter we talked a lot about our content ingestion process. I think we're doing a much better job of, using AI and technology rather than onshore and offshore people resources in order to manage our content ingestion process that is certainly having a positive impact. As you know, we did make a change to our contributor royalties where there's an annual check as to the payout profile to contributors, and I think that's having an impact at this point in time during the year. I think there's also a significant impact from the change in paid downloads. If you kind of track the paid downloads, they've gone from down 1% to down 5.6% to down 6.2% in this quarter. And that does have a meaningful impact in terms of the cost of goods sold and hence the gross margin profile. So we don't expect that the gross margins at this level are sustainable. We think they will come back down We are confident that paid downloads will tick back up as utilization improves. We think that is going to start to happen in the fourth quarter as well as into next year. And so we think you'll see some of the upside we've experienced in gross margin start to reverse itself. But suffice it to say, there's a number of things that we're doing, including working on reducing our cost of credit card acceptance, lowering our interchange fees, and a number of other things to really work around the edges to keep gross margins as sustainable as possible. But again, we don't think they're going to stay at these levels. We think they will be reverting back to where they've been historically over the course of the last several quarters.

All right, that's helpful. Thank you.

Our next question comes from the line of Brad Erickson with Needham & Company. Go ahead, please. Your line is open.

Hi, thanks. Just a couple. So first on the subscription acceleration, I guess beyond just, you know, broad-based recovery and demand you talked about, were you doing anything different there either on performance marketing channels or is your messaging different in any channels for either new or existing customers? Just curious what may have driven the faster shift over to subscription that we saw in the quarter.

Yeah, so I'll take this one. You know, one of the big changes we've made is that we've introduced subscriptions that are smaller in nature for smaller businesses, both on the image side as well as footage, and then most recently with PremiumBeat. And so from a marketing perspective, we do address our audiences differently in terms of how we go to market. the channels that we use, the type of copy that we use, how much we spend to acquire customers relative to the lifetime value, as well as how we communicate with those customers once they become either subscribers of our emails or subscribers of our products. So we do have a segmentation approach to acquiring these customers and That has been very helpful. If you look at the subscriber revenue growth relative to the subscriber growth overall, that's where you can kind of see how the impact of our smaller subscriptions are having on overall revenue relative to the much more accelerated growth in overall subscribers.

Got it. That's helpful. And then just to follow up on the e-commerce side of the business, I know you said the rebound there was broad-based again, but just curious to get a little bit more subsector detail if we could. I imagine advertising and things like digital commerce came back fairly well. Just curious if you can call out any other categories that showed sort of outperformance type of improvement in the quarter. Thanks.

Yeah, so I think we continue to see momentum around particularly as companies were getting ready for their Q4 push, both in combination of back to school as well as early holiday, as well as you've seen all sorts of movements around things like Amazon's Prime Day and what that did to the overall retail sector. as well as some other categories of spend that have started to sort of come back. So what I would say is this was kind of a little bit more of, you know, coming back to normal for several categories, particularly in e-commerce, continued growth in the small and medium business segment. We do continue to see softness in, in some very large categories, such as auto, such as travel, which continue to be impacted by the pandemic. But, you know, we did see some acceleration in some of the categories that we saw growth last quarter as well.

Got it. That's great. Thank you.

And again, as a reminder, if you'd like to ask a question, please press star followed by the number one on your telephone keypad. And our next question comes from the line of Ron Josie with JMP Securities. Go ahead, please. Your line is open.

Great. Thanks for taking the quarter and taking the question. And Stan, I wanted to talk a little more about subscriptions. You mentioned you're aggressively investing here and understood the lower price plans, but can you talk about the profile of those that are buying these subscriptions? I think you just mentioned SMBs and and whatnot, but just curious about those who are buying subscriptions. We mentioned prosumers in the past, and I'm also curious if you can talk a little more about platform solutions and how that might be helping the broader growth, but then also for subscriptions. Thank you.

Yeah, absolutely. So, you know, today most of our subscriptions are in our e-commerce area. As we continue to invest, we're going to create more and more subscription products, both in the enterprise as well as platform solutions. So, you know, today a lot of the smaller subscriptions are sort of tailored for a customer that needs self-serve capabilities. They're not looking for an account manager to sort of help them. They're looking for, you know, they know that they're going to develop certain projects over the course of the year, and they need a simple way to do that. When we think about investing in subscriptions, the way we think about it is today our subscriptions are sort of tied to different sets of content that we make available or allotments of content that we make available at price points. One of the things that I talked about on the script as well as previously is the fact that we're going to continue to evolve our subscriptions with services. So you can imagine as we continue to develop, for example, in the enterprise, our Shutterstock Studios business, those types of services will become a part of our overall creative subscriptions. We will start to make more and more workflow services available as part of our subscriptions, and those will be targeted at various audience types. So when we think about our subscription growth, that's something that we're definitely going to look at across all of our channels. But today that is predominantly an e-commerce driven sort of area. With Platform Solutions, this has been a really successful channel for us and continues to be a really successful channel. We are starting to introduce new products within the channel, so not just content. We are launching services within that channel as well, including editing, including leveraging our data sets and computer vision. So we are actively working on sort of developing different subscription products for that channel as well. However, today, the way those contracts are written, we don't classify most of those as subscriptions. So more to come in terms of how the subscription profile will evolve across all of our channels, but ultimately, A lot of that is tied to how our customers, you know, purchase and their purchase behavior. And we do see an opportunity to drive subscriptions across three of our sales channels.

That's great. Thank you. Our next question comes from the line of John Egbert with Stiefel. Go ahead, please. Your line is open.

Great. Congrats on the results. Thanks for taking my question. So it looks like you had a nice inflection in gross billings and a significant improvement in the enterprise revenue relative to the past few quarters. And that seems like a reasonable timeline for that segment to return to growth. I was wondering if you could talk about the evolution of your enterprise sales strategy as you've evolved the sales organization. I know you've talked about using e-commerce to fuel some enterprise sales, for example. I'm just curious the steps you've taken in the last few months. Yeah, absolutely.

It's interesting. I've been talking about enterprise for several quarters and how our strategy was changing from purely sort of a very transactional approach that we had historically in the enterprise to much more of a strategic partnership approach. That started with a realignment of the team around segmenting our customers to First and foremost, aligning the comp plan to focus on larger average order values aligned around objectives of creating relationships within the enterprise. And one of the biggest impacts that we've had to the businesses is the team itself. We brought on a new CRO, Jamie Eldon, who has done an amazing job We have an incredible sales operations team. And the go-to-market has changed as we sort of talked about that we needed to. We've launched some new products and services. So if you think about what we offer today, it's not just creative. It's creative services. It's workflow services. And it's working. Our customers, particularly today in this environment, when you need a global solution, to drive your creative needs. We can do that at scale. We can do that very cost effectively. So where we're finding success is actually, it's interesting, we're seeing it across all of our enterprise verticals, including media, including agency, et cetera. But also within our enterprise, we also have a small and medium business segment and a business team. that is entirely focused on both new customers as well as retention of existing customers. And that segment is growing very nicely for us as well as part of enterprise. So I think what I would say is our move from sort of a transactional organization to a much more strategic partnership organization is having some success, and I'm very proud of the team and the results that they're bringing in.

Great. Thanks. Our next question comes from the line of Yusuf Squally with Truist Securities. Go ahead, please. Your line is open.

Oh, thank you. I just have a couple of follow-ups, maybe one. For you, Stan, on the last question, you guys have talked about improvement to workflow and innovating that area for the enterprise channel for quite some time now, but it seems like that's a renewed area of interest. Can you maybe just help us? What's different now? How are you guys going about it differently? this time around. I think you talked about some self-serve capabilities, some data launches and what's not. So that will be really helpful. And then in the presentation that you guys have on the microsite, you guys highlighted first-party data assets as an area of opportunity. Can you flesh that out a little bit for us in terms of what kind of products you guys are seeing potentially coming out of there and And are you, you know, presently in the market with anything for that? Thank you.

Yep. Yeah, so, you know, Yousef, as I talked about before, you know, I believe for our company to be successful, we need the combination of content, workflow, as well as data. assets, and this is what really differentiates us is the fact that we want to bring all three of those through all of our sales channels. Unlike many of our competitors, we think about ourselves as an open platform. So when we work, for example, when we work with our partners in platform solutions and we're leveraging, for example, computer vision internally for how we either ingest content or how we look for content that is brand safe or has certain characteristics, those services we've started to make available, for example, through platform solutions because many of our customers have those needs. They have image recognition needs. They have needs around content that they manage internally. So when we think about workflow and our seriousness about providing more services, this isn't about sort of us competing on any one tool or monetizing any one tool. It's about when we bring collaboration services like with workspaces, right, where we allow customers to ideate, collaborate, share content, as part of their initial workflow, that is a part of our subscription product. That's going to be how we continue to develop retention and engagement around our subscription products. As we start to leverage our first-party data more and more for recommendations and more and more for performance, those are going to be part of our subscription products that we bring across all of our sales channels. So some of these are in market, like the computer vision example that I've just used. Some are in beta right now with customers. But as we launch these products and as they become much more widely available, we'll provide a lot more information as well as usage and sort of how they're impacting our subscription numbers in upcoming quarters. But we just wanted to really let the community know that this is an area that we're very serious about making investments in, and it's based on research from our customers. The types of workflow services that we're bringing are entirely based on what our customers have asked us to bring them.

Sounds good. Thank you. Thanks.

And there are no further questions in queue at this time. I'd like to turn the call back over to CEO Stan Pawlowski.

Thank you so much. I'd like to, again, say and express my gratitude to our employees, our customers, and our contributors for their support and encouragement. I continue to be so excited for the road ahead as we continue to take advantage of the opportunities that we have in front of us. And with that, that ends our call for today. Thanks, everyone.

Ladies and gentlemen, this does conclude today's conference call. You may now disconnect.