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Shutterstock Inc (SSTK 0.74%)
Q2Â 2019 Earnings Call
Aug 6, 2019, 8:30 a.m. ET
Contents:
- Prepared Remarks
- Questions and Answers
- Call Participants
Prepared Remarks:
Operator
Hello, ladies and gentlemen, and welcome to the Q2 2019 Shutterstock, Inc. Earnings Conference Call. [Operator Instructions] I would now like to turn the conference over to your host, Ms. Heidi Garfield, the Corporate Secretary. Heidi, please go ahead.
Heidi Padawer Garfield -- Vice President General Counsel and Corp. Secretary
Thank you, operator. Good morning, everyone, and thank you for joining us for Shutterstock's Second Quarter 2019 Earnings Call. Joining me today is Jon Oringer, our Founder, Chief Executive Officer and Chairman; Stan Pavlovsky, our President and Chief Operating Officer; and Steve Ciardiello, our Interim Chief Financial Officer and Chief Accounting 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 long-term effects of our 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, our growth potential, potential future results of efforts to reduce our expense footprint and implementation of large-scale business solutions and our 2019 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 Factors in the company's annual report on Form 10-K for the year ended December 31, 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 EBITDA margin, adjusted net income, revenue growth on a constant currency basis and free cash flow, all of which are non-GAAP financial measures.
You can find a description of these items 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 connection 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. Finally, please refer to the brief information deck we posted on our website that contains supporting materials for today's call.
And now I'll turn the call over to Jon.
Jonathan Oringer -- Founder, Chief Executive Officer and Chairman of the Board
Thanks, Heidi, and thank you, everyone, for joining us today. As you have seen in our press release this quarter, we continue to see demand from our customers around the globe, resulting in further revenue growth and strengthening our working capital position. However, we have announced that we are revising our full year 2019 guidance. Stan Pavlovsky and Steve Ciardiello will be providing more details shortly. But at a high level, we have some immediate issues to address, particularly in our enterprise sales channel that demand a critical reevaluation of how we drive renewed growth.
As a team, we are now taking this opportunity to carefully evaluate all aspects of our enterprise sales channel, and we have recently made some changes that we think will have a positive impact. The potential for this business remains significant. The marketplace is quickly evolving as are the challenges that our customers face. We believe we are the best positioned platform in our competitive landscape to capture these opportunities. Now, more than ever, users turn to our platform to deliver solutions to meet their rapidly changing needs.
We think we can do more for them and do it even better. We are looking at improving some areas within the e-commerce channel in order to get us back on a stronger growth trajectory, better optimize our existing products and services and find opportunities for new sustainable revenue streams over the next several years. Even though we revised our outlook for the year, we made some positive strides in the quarter. Revenue in the second quarter of 2019 grew 3% from 2018 on a reported basis. Revenue from our e-commerce channel grew 6% to $97 million as compared to the second quarter of 2018, while our enterprise channel remained flat at $64.7 million.
Adjusted EBITDA grew 4.4% from the second quarter of 2018, resulting primarily from our revenue growth. We further strengthened the stability and scalability of our platform this quarter and increased the percentage of its cloud enabled to almost 90%. As always, we make our content tools and platform available anytime and anywhere.
We introduced new footage offering and -- we introduced our new footage offering, Shutterstock Elements, which offers cinema-grade video effects for filmmakers. Our free design application, Shutterstock Editor, surpassed more than 5 million users, demonstrating strong support from customers. We launched our new self-serve API subscription plans, reflecting a demand for increased access and support to further serve our growing community of developers, start-ups and small and mid-sized businesses.
We added more than 150,000 contributors and $20 million assets to our marketplace in Q2. And we saw continued positive traction for a promotional campaign, "It's not stock, it's Shutterstock." We are proud of these results and recent initiatives. And when we take a step back and look across our business, we have been and continue to be growing and profitable with strong cash flow and a clear strategy focused on 3 pillars: platform, network and talent.
When we started Shutterstock, our goal was to build a creative platform that provided customers with the most compelling content, tools and services. At our core, we are a disruptive technology company and it's through this lens that we are looking toward the future. We know that we have to keep pushing ourselves to stay at the forefront of the industry, and constantly improving and building on our technology, being relentlessly innovative for our customers and contributors will fuel our growth and success. Today, we have a strong brand that our customers rely on with the tools and content they need to be successful. 6x per second, 1 of our 1.9 million customers, licensees to creative access from our marketplace.
That data drives our contributors to shape the extensive library we sell day after day. This powerful network effect that we have created, refined and improved upon over the years gives us a strong platform to build other products and services off of. Additionally, we have repositioned our management team to plant the right seeds to capture these opportunities. As we look ahead, we will be making some operational improvements to further enhance our platform, with the renewed dedication to stay ahead of our customers' ever changing needs. Customer and contributor engagement is our priority, and I'm confident that we have the right tools and team to get back to our roots, thinking big and acting bold.
To that point, we have recently added fresh perspectives to our management team. As you know, we elevated Stan Pavlovsky to President and Chief Operating Officer. In this role, Stan will leverage his expertise in managing the strategic and operational aspects of technology-focused businesses to better position Shutterstock for success long into the future. Stan is the right person to lead our sales, product, technology and marketing teams as they continue to execute our platform and network strategy and drive the continuous improvement of the customer and contributor experiences.
We are also in the midst of a comprehensive search process for our next Chief Financial Officer and are grateful that Steve Ciardiello, our Chief Accounting Officer, is filling that role in the interim. In addition, our people are at the heart of our success, and we are confident that we have the talent across our organization to help us accomplish our goals.
We remain focused on employee engagement and committed to attracting and retaining the best people to deliver on our vision and further our collaborative and innovative culture. I'd also like to take this opportunity to welcome a new Director to our Board, Rachna Bhasin. Rachna currently is Founder and CEO of EQ Partners and Co-Founder of Pacifica Investments, where she operates as a strategic advisor, investor and consultant to early stage technology and media companies.
Prior to January 2019, Rachna served as Chief Business Officer for Magic Leap for over 3 years and previously was the SVP of Corporate Strategy and Business Development at Sirius XM Radio in New York. She brings deep industry knowledge and strategic vision, which complement our existing Board members' perspectives as we look to drive Shutterstock's performance.
We look forward to her contribution and guidance. Before I turn the call over to Stan to discuss the business strategy in greater detail, I want to underscore our confidence in our path forward as we reinforce our position as an industry-changing technology company. Shutterstock's long-term global market opportunity remains strong as we differentiate our growing brand and leverage our innovative technology. We are firmly focused on successfully executing on our strategy that will drive revenue and earnings growth, improve margins and increase cash flow. And we remain committed to delivering increased value for our customers and our shareholders.
And with that, I'll turn it to you, Stan.
Stan Pavlovsky -- President and Chief Operating Officer
Thanks, Jon, and good morning, everyone. It has been a great few months since I joined the company, and I want to thank the management team and the company as a whole for giving me such a warm welcome. I'd like to accomplish a couple of things this morning. The first is to provide some of my initial impressions after my deep dive into the business, and the second is to identify key focus areas for the company going forward. I've hit the ground running since starting this past April.
And while it's still early in my tenure, I've had the opportunity to meet a lot of talented colleagues and have been impressed by their passion and contributions, and much of what I've seen confirms my belief in the strength and potential of this company. Shutterstock is a leading innovative technology company that has developed an unparalleled creative platform. We have a strong reputation for high-quality content, solutions and services. Over the past few months, I have worked closely with Jon and the operational heads across the business, including product, technology, sales and marketing teams.
It's clear that we have a number of great business lines that we can and will continue to leverage, including some that are newer and smaller but have big potential. As we continue to innovate around our core business with a unified platform, we see further opportunities to grow. We are also identifying new areas that will provide additional value to customers, which we are confident will drive sustainable growth for the long term. It's no secret that the needs of our customers, their businesses and how they operate changes rapidly.
The need for high-performing authentic content that works across a range of platforms is growing. We need to further our efforts to demonstrate to customers that we have the right content, products and services to make them successful. From what I've seen at Shutterstock, I'm confident that we can make this happen. We are well positioned to help our customers be successful by leveraging our vast library, cutting-edge technology and exceptional customer service. Our goal is to enable our users to do what they want as fast and as efficiently as possible.
The improvements we are making all trace back to this fundamental yet critical goal. Focusing on our enterprise channel, we are in the process of enhancing our sales effectiveness and go-to-market strategy. We are better aligning our sales team to reflect the customers' needs and the competitive marketplace in which we operate. Internally, this includes organizational improvements, reviewing our incentive structures and improving our back-end business systems. We are also taking a fresh look at our sales and marketing positioning in order to better present a unified value proposition to our customers.
Within our e-commerce channel, the costs associated with acquiring customers has increased. To address this trend, we are developing an integrated marketing strategy with a focus on activities that drive higher ROI, conversion rate and customer lifetime value. Optimizing the lifetime value of our customers will allow us to invest more thoughtfully and with greater impact. In addition, we are continuing to launch new products and evolve our existing products to offer uniquely meaningful solutions to our customers around the world.
This includes our new footage offering, Shutterstock Elements. This product introduced over 3,000 elements captured on cinema-grade cameras and lenses, which are compatible with all major video editing programs. We also enhanced the user experience and our consumer mobile apps by adding 14 languages, bringing the app up to par with 21 languages served on our site. We enhanced our conversion and usage by streamlining the download experience and unifying the checkout experience for image and footage. And we've launched a View in Room augmented reality feature for our iOS app, allowing users to visualize how images from Shutterstock might look in real-life settings.
These and other initiatives are driving us to achieve our goal, helping users accomplish their goals as fast and efficiently as possible. We believe that innovating across our creative platform will continue to drive growth in our core business and unlock new revenue opportunities. We have a lot of important work ahead of us, and our team is working thoughtfully and with urgency.
I joined this team because I share their confidence and our ability to execute on the long-term opportunities this company has with passion for innovation and operational excellence. Moving forward, our strategy positions us well to constantly discover ways to improve customer and contributor experiences and deliver value for our investors. I'm excited to be part of what comes next for Shutterstock and to work closely with Jon and the rest of this great team to further build on Jon's vision when he founded this company. I look forward to updating you on our progress on future calls.
And with that, I'll turn the call over to Steve for a more detailed financial review.
Mr. Steven Ciardiello -- Interim Chief Financial Officer and Chief Accounting Officer
Thank you, Stan, and thank you, everyone, for joining us today. First, as Jon mentioned earlier, while we continued to have profitable growth in the quarter, improved our liquidity and had strong free cash flow, we have additional work ahead of us and are not satisfied with the results of our enterprise channel. Revenue growth as reported in the second quarter was 3%. Excluding the impact of foreign currency movements, revenue growth was approximately 5% in the second quarter as compared to 2018. Our e-commerce channel revenue increased 6% to $97 million as compared to the second quarter of 2018.
And on a constant currency basis, e-commerce revenue grew 7%. Our enterprise channel revenue of $64.7 million was flat compared to 2018 on a reported basis and grew 2% on a constant currency basis. As a reminder, approximately 1/3 of our revenues are denominated in foreign currencies, with the majority in the euro and the British pound sterling. FX movements to the U.S. dollar will impact our reported revenue growth. Reviewing some of our key metrics in the second quarter on a year-over-year basis, paid downloads grew by 3% to $46.6 million, revenue per download increased 1% to $3.44 per download.
Our image library expanded by 37% to over 280 million images and our video library increased by 36% to over 15 million clips. Operating income was $3.1 million in the second quarter, a decrease of 45% from $5.6 million in the prior year and adjusted EBITDA for the quarter grew 4% to $25.1 million, which compares to $24 million in the same period a year ago. Our adjusted EBITDA margin grew 17 basis points to 15.5% in the second quarter of 2019 compared to the prior year.
While our revenue growth was below our expectations, we continued to invest in our technology and platform to enable long-term profitable growth. GAAP net income in the second quarter was $3.3 million or $0.09 per diluted share, an increase from a net loss of $300,000 or $0.01 loss per diluted share in the second quarter of 2018. As a reminder, in the second quarter of 2018, we recorded a $4.8 million after-tax impairment charge. Adjusted net income was $11.8 million or $0.33 per diluted share for the second quarter of 2019 as compared to $10.7 million or $0.30 per diluted share in the second quarter of 2018, representing a 10% increase year-over-year.
Now the following discussions on operating expenses in the second quarter of 2019 will exclude stock-based compensation expense and will be compared to the second quarter of 2018. Total operating expenses increased 4.4%. This increase was driven primarily by increased general, administrative and direct marketing expenses, offset by a decline in product development expenses. Our cost of revenues, which include contributor royalties, increased 1%.
Our contributor royalty expense continues to be approximately 26% of revenues. Sales and marketing expenses increased 6% due to increased spending and marketing initiatives. Sales and marketing expense was 27% of revenue in the second quarter of 2019 as compared to 26% in the second quarter of 2018. Product development expenses decreased 18%, primarily due to lower personnel and consulting costs. As a percentage of revenue, product development costs were 8% for the quarter versus 10% in the 2018 period. In addition, during the quarter, the company capitalized $5.8 million of labor costs related to product development. G&A expenses increased 29% from the second quarter of 2018.
And sequentially, G&A expenses increased $2.5 million or 11% from the first quarter of 2019. This increase includes onetime costs associated with severance benefits and accelerated amortization. As a percentage of revenue, G&A expenses were 16% as compared with 13% in the second quarter of 2018. Our income tax expense was $355,000 compared to a tax benefit of $1.1 million in the second quarter of 2018. Our second quarter of 2019 effective tax rate was 9.7%. Cash taxes paid in the quarter were $1.2 million as compared to $1.7 million in the second quarter of 2018. Now on to the balance sheet. Our deferred revenue balance as of June 30, 2019, was $137.1 million, of which approximately 40% relates to our e-commerce business and 60% to enterprise. This mix is consistent with prior periods.
At June 30, we had approximately $259 million of cash and cash equivalents. We continue to maintain a strong positive working capital position. For the second quarter, net cash flow from operations was $27 million, an increase of $10.1 million from the second quarter of 2018. Additionally, in the quarter, free cash flow was $19.8 million, an increase of $11.6 million from the second quarter of 2018. Free cash flow is cash flow from operations less cash payments for capital expenditures and content purchases. We had higher operating cash flow in the quarter compared to 2018.
And in addition, our capital expenditures declined to $6.5 million from $8.1 million in the second quarter of 2018. We actively manage our capital expenditures and believe that the current levels are reasonable for a business of our size and growth. 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. As we have done historically, we will continue to evaluate the appropriate use of cash generated in our business to optimize return for stockholders. And finally, getting to our updated guidance.
Based on weaker-than-expected revenue growth and the company's committed strong focus on our enterprise sales channel strategies in the second half of the year, we are reducing our full year revenue growth target to $645 million to $670 million from our previous guidance of $685 million to $695 million.
This reduction will also impact our previously guided adjusted EBITDA and operating income targets. As a result, our updated expectations for the full year 2019 are now as follows. Revenue of $645 million to $670 million, adjusted EBITDA of $93 million to $107 million, income from operations of between $18 million to $32 million, noncash equity-based compensation expense of approximately $25 million, capital expenditures including capitalized labor of approximately $32 million and an effective tax rate in the teens. As we have mentioned, the company focuses on long-term profitable growth, and we will continue to invest in our business through 2019 and beyond and maintain our strong working capital position and free cash flow.
We appreciate your time today. And now Jon, Stan and I will be happy to answer any questions you may have. Joan, can you please prompt the participants for questions.
Questions and Answers:
Operator
[Operator Instructions] Your first question comes from the line of Youssef Squali from SunTrust. Your line is open.
Youssef Houssaini Squali -- SunTrust Robinson Humphrey -- Analyst
Okay great. Thank you very much. Good morning guys.Just a couple of questions, I guess, from us. Starting with the -- just with the e-commerce part of the business, it sounds like the marketing efficiency in that business has waned a little bit. I think you spoke to the cost of customer acquisition having gone up. Can you just parse out for us the effects from potential competitive pressures versus things that you're doing internally that may have caused that to happen?
And maybe just broadly speaking, Jon, kind of what you're seeing broadly competitively? And second, on the enterprise side, Stan, I think you talked about what you guys are doing to try to reinvigorate growth in that segment. I think you also spoke about -- one of the things you spoke about the sales and marketing or repositioning using sales and marketing. Maybe you can kind of flesh that out for us a little bit? What exactly are you guys doing there? Are you introducing newer products at a different price point? Or just kind of any kind of color there would be very helpful.
Jonathan Oringer -- Founder, Chief Executive Officer and Chairman of the Board
Thanks, Youssef. I'll start with e-commerce and then I'll hand it over to Stan for enterprise. As far as the cost of acquisition goes, that's a pretty -- it's happening across all industries when you look at kind of using quantitative methods to produce results from paid advertising. The cost has increased there. But what we see is that with our data, we can get a bit smarter and zoom in on the leads that make the most sense for the e-commerce business and the ones that don't.
One great thing about our platform is that the data velocity is really high. Selling 6 images per second, the most out of anyone we know in this industry by far, we can collect a lot of information to really shape our library and target our content in a way to prospective customers at the top of the funnel in a way we don't believe others can. So while we see the competitive pressure increase and the cost of that -- those acquisitions going up a bit, we also believe we're best positioned and it's not unique just to us in our industry or even other industries. As far as enterprise, Stan, you want to jump in?
Stan Pavlovsky -- President and Chief Operating Officer
Sure. This is Stan, Youssef. On the enterprise side, we are focused on the go-to-market strategy. When you think about market trends around consumer consumption of content and the time spent with content and then the subsequent pressure on our customers and clients to create an increase in the amount of content that's authentic, that is fresh, that's culturally relevant, we have a great opportunity to better position how we're able to deliver that with our clients. And so pricing and packaging is one piece of it, and that's kind of the blocking and tackling of the business, but how we communicate the tools and services that we provide is how we will build sort of deeper relationships with our client base.
Operator
Your next question comes from the line of Alex Giaimo from Jefferies. Your line is open.
Alexander Joseph Giaimo -- Jefferies LLC -- Analyst
Thanks for taking the question. Just going back to the enterprise side. Can you just help us parse out the main cause for the softness? Do you feel its broader industry pressure or were there fundamental challenges in the quarter? I guess, asked differently, do you feel like the industry is still growing on the enterprise side? And then just given the recent management changes, are there any changes we should be aware of going forward, maybe the way you guys will provide outlook or just anything to call out with the CFO turnover.
Jonathan Oringer -- Founder, Chief Executive Officer and Chairman of the Board
Sure. Thanks, Alex. Let me just -- I'll start with your first question here, and then I'll let Stan jump in also on the enterprise side. So we believe the main cause for softness is our own operation. If you think about how the enterprise business grew, it was out of the e-commerce channel. So what we did was we learned how our e-commerce customers interact with our site.
We saw multiple users from different companies. We started to reach out to those customers and we started to realize there were other customers in those organizations also, and we built team subscriptions in our premier product, which is a different set of features for the enterprise customer. While these challenges exist, we believe the market is still growing because all businesses need images.
And if you look at the 60 million small businesses out there and the 1.9 million businesses that we currently serve, there's a big gap. And we can continue to build that. Each one of those small businesses could use the team subscription to build their own business. And we intend to organize our data in a better way and our team to seize on this opportunity. Anything else from on the enterprise side, Stan?
Stan Pavlovsky -- President and Chief Operating Officer
Yes. I'll just add a little bit to that. If you really think about our platform and what we offer and the workflow of our customers and clients, both the content creation capabilities, whether it's stock or whether it's custom or whether it's editorial coupled with services that we're able to provide around workflow, that combination and that value, we have to do a better job of communicating into the marketplace.
And so obviously, with the enterprise when you talk about our go-to-market strategy, when you talk about building deeper relationships with clients, it's a longer sales cycle. But having the right team in place and having the team organized around these core tenants we believe will help us as we focus on the current set of products that we have, but also the products that we plan to launch over the next 6 to 12 months.
Jonathan Oringer -- Founder, Chief Executive Officer and Chairman of the Board
And Alex, on your second question, as far as our CFO search, so Steven left the company to pursue other opportunities. And currently, we're in market executing on a very comprehensive CFO search at the moment to find the next CFO for the company. And as you know, Steve Ciardiello is our Interim CFO.
Operator
Your next question comes from the line of Lloyd Walmsley from Deutsche Bank. Your line is open.
Lloyd Wharton Walmsley -- Deutsche Bank -- Analyst
On the enterprise following up there, it sounds like you're still evaluating the changes in strategy. Can you just give us a sense or the time line of figuring out what the plan will be implementing that plan? What the issues may be in any transition period around changes to sales force compensation, etc.? And then secondly, it looks like Europe, in particular, was a little bit weaker. Anything you'd call out there? And then last one was just you have a buyback authorization, haven't bought back shares in a while. How are you guys feeling about deploying cash from the balance sheet?
Jonathan Oringer -- Founder, Chief Executive Officer and Chairman of the Board
Thanks, Lloyd. Yes. So as far as the time line, we're only giving 2019 guidance as we said before, but this is something that will evolve. We believe we've identified some areas in enterprise that are low-hanging fruit that we can seize on immediately, but we also don't manage the quarters. So there could be investments that we'll make in this business in order to benefit enterprise, e-commerce or other parts of the business that will take a payback period that's a lot longer than the quarter or the year because we believe in the business. As far as the buyback authorization, yes, we have $100 million more authorized from the Board.
As far as our capital allocation strategy goes, our first priority is investing in this business to drive an appropriate level of return. And we believe that through a recent strategy session, there are other areas we can invest in order to build new products and services off of our platform, just like we did many years ago building the enterprise product off of the e-commerce platform. So we believe that there's a lot of improvement in editorial, in custom, in enterprise, in e-commerce.
We also, on the capital allocation point -- I'm sorry, we paid out $100 million dividend last year. So we are always evaluating the amount of cash we have, what we can do with it and how it will best benefit our shareholders. About the Europe business, Lloyd, sorry, I think I just missed that part. I'll just jump in on that. We don't comment on the regional ups and downs of the business. There are several levers that can cause and a lot of different factors that can cause the up and down in any given quarter. The enterprise business deals are bigger, so they're choppier. And that's where we are.
Operator
[Operator Instructions]
Jonathan Oringer -- Founder, Chief Executive Officer and Chairman of the Board
Okay. It looks like there are no other questions. Thanks for joining us, and we'll see you next quarter. Operator?
Operator
[Operator Closing Remarks]
Duration: 36 minutes
Call participants:
Heidi Padawer Garfield -- Vice President General Counsel and Corp. Secretary
Jonathan Oringer -- Founder, Chief Executive Officer and Chairman of the Board
Stan Pavlovsky -- President and Chief Operating Officer
Mr. Steven Ciardiello -- Interim Chief Financial Officer and Chief Accounting Officer
Youssef Houssaini Squali -- SunTrust Robinson Humphrey -- Analyst
Alexander Joseph Giaimo -- Jefferies LLC -- Analyst
Lloyd Wharton Walmsley -- Deutsche Bank -- Analyst
