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Good day, ladies and gentlemen, and welcome to the Second Quarter 2018 Shutterstock Incorporated Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. As a reminder, this call is being recorded.
I would now like to turn the conference over to Amy Behrman, Senior Director of Corporate Development, Strategy and Investor Relations. You may begin.
Thank you, operator. Good morning, everyone and thank you for joining us for Shutterstock's second quarter 2018 earnings call. Joining me today is Jon Oringer, our Founder, Chief Executive Officer and Chairman; and Steven Berns, our Chief Operating and Chief Financial Officer.
During this call, management may make forward-looking statements that are subject to risk and uncertainties, 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 and profitability, our long-term strategy, our growth potential, potential future results of efforts to reduce our expense footprint, and implementation of large-scale business solutions and our 2018 guidance. Our actual results may differ materially from the results predicted. And reported results should not be considered as an indication of future performance.
Please refer to today's press release and the reports and documents we filed 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, 2017 and quarterly report on Form 10-Q for the quarter ended June 30, 2018 for discussions of important risk factors that could cause actual results to differ materially from those discussed in any forward-looking statements, we may make on this call.
On this call, we will refer to adjusted EBITDA, adjusted net income, revenue growth on a constant-currency basis, including and excluding Webdam, revenue per download on a constant currency basis and free cash flow, all of which are non-GAAP financial measures. You can find the description of these items, along with a reconciliation to the most directly comparable GAAP financial measure in today's earnings release, which is posted on the Investor Relations section of our website.
We believe that the use of these measures in conjunction with GAAP financial measures allow investors to consider our operating results on the same basis used by management. This provides them with important additional insights about the company's overall business and operating performance, and enhances comparability in assessing our financial reporting. However, these non-GAAP financial measures should not be considered as a substitute for, or superior to, financial information prepared in accordance with GAAP.
Lastly, as a reminder, we sold Webdam in the first quarter of 2018 and therefore Webdam did not contribute to our second quarter 2018 operating results. However, Webdam was included in our 2017 results and therefore some of our commentary today will specifically state that we are excluding the results of Webdam, meaning that we are excluding it from the second quarter of 2017 to provide a comparable basis to the second quarter of 2018.
And with that, I would like to turn the call over to Jon.
Thanks, Amy, and thank you everyone for joining us today for Shutterstock's second quarter 2018 earnings call. Our second quarter showed continued improvement in revenue and profitability with revenue increasing 16.9% on an as reported basis. Excluding the impact of Webdam and the impact of foreign currency movements, second quarter revenue increased 17.7%. Adjusted EBITDA grew 31.1%, driven primarily by strong revenue growth and continued cost management efforts. The investments we have made in our technology and product offerings over the past couple of years have begun to yield promising operational and financial returns. Our e-commerce channel grew 11.6% in the quarter, the highest level of growth since the fourth quarter of 2015.
This acceleration of growth was enabled by our new technology platform and related improvements we have made. Activities that contributed to this quarter's performance included launching innovative pricing and packaging, resulting from our improved testing environment and optimization of our customer acquisition funnels.
In addition, in our continued efforts on localization, we launched customized pricing pages, landing pages and Express Checkout experiences tailored to different customer segments. We also invested in a number of global marketing initiatives to drive additional traffic and further accelerate top line growth. We plan to continue to invest in these marketing activities and expect them to pay out over time.
Our enterprise business continued its strong performance with 34.9% growth in the quarter as a result of our enhanced customer experience, features and functionality and improved site performance. The enterprise channel represented 41% of our total revenue in the quarter as compared to 36% in the same quarter of 2017.
In the second quarter, we continued to invest in a variety of tailored marketing initiatives and sales efficiency processes to support future growth. Furthermore, in the Asia-Pacific region, we continued to expand our sales capabilities by adding incremental enterprise sales resources in strategic locations.
As part of our strategy to give customers access to Shutterstock everywhere they may need it, in the second quarter, we announced the partnership with the IBM Watson Content Hub, offering their marketing customers the chance to discover imagery and music from Shutterstock's library, as well as the ability to edit images using Shutterstock Editor Pro, and this adds to our growing list of partners, including Facebook, Google, Microsoft, Wigs, Snap, HubSpot and Insightly (06:44).
We've also continued to improve our product by providing our customers with more personalized and localized experiences. Late in the second quarter, our PremiumBeat music site launched in 21 languages, up from the two languages it previously supported, bringing it on par with Shutterstock.com's language offering, and enabling many customers to quickly search our curated library, high quality music tracks in their local language. Across our entire platform, we are further localizing our customers' experience by building out the ability to accept payments in more local currencies and offering all of the payment methods our customers need.
Another area of focus and investment had been our suite of workflow tools. We launched to a targeted group of customers a feature-rich professional version of our Shutterstock Editor in browser tool referred to as Editor Pro. The results have been extremely promising with high levels of customer engagement. We also launched Shutterstock Showcase, a suite of easy-to-use, innovative AI and deep learning power tools, which integrate seamlessly into our customers' workflows and enhance their search and discovery experience.
Our Custom product, which we purchased almost a year ago, continues to grow nicely. We are focused on scaling Shutterstock Custom by refining the sales and marketing strategy and building additional product functionality.
Our editorial business continued its growth, primarily driven by expanding relationships with new media customers and increased coverage of entertainment and breaking news events. Key events we covered in the second quarter include the British Royal Wedding and the World Cup, which drove incremental activity for the business.
As we look to accelerate future growth, we are working to collaborate more closely with our strategic partners in order to optimize the value we are creating from marketing, sales and content production efforts. This quarter, we celebrated the 15th anniversary of the company. Since the launch of Shutterstock 15 years ago, more than 450,000 photographers, videographers, musicians, artists and designers have become contributors to our platform, earning them nearly $650 million in royalties. Our platform has empowered customers with compelling content, innovative tools and valuable services that drive faster, more efficient content discovery and creation.
In summary, we've made a lot of progress in the first half of 2018. During the remainder of the year, we will continue to execute on our strategy, which, we believe, will continue the momentum we have been building in the first six months of this year.
Finally, as Steven will detail in his remarks, our Board of Directors has declared $3 per share special one-time cash dividend. Based on our strong operating cash flows, proceeds from the sale of Webdam and other factors favorably impacting our cash position, our Board of Directors believe that declaring this special dividend is consistent with our strategy of maximizing stockholder returns while allowing us to maintain a capital structure to fund our operations and growth initiatives.
And with that, I'll turn the call over to Steven.
Thanks, Jon, and thank you everyone for joining us today. Before I discuss our performance, as always, I want to let you know that we have posted a brief information deck on our website that contains supporting materials for today's call.
As Jon has highlighted, we continued to execute against our strategic objectives throughout the quarter, resulting in revenue growth on a reported basis of 16.9% compared to the second quarter of 2017 and an adjusted EBITDA margin of 15.4% in the second quarter of 2018.
Two items, which impacted our revenue growth in the quarter, were the sale of Webdam, which occurred in the first quarter of this year and foreign currency fluctuations. Excluding the impact of foreign currency movements, revenue growth was approximately 14.4% in the second quarter as compared to 2017. In addition, if you exclude the impact of Webdam from 2017's second quarter, revenue growth was approximately 20.2%. Excluding both FX movements and Webdam, revenue grew 17.7% in the second quarter of this year. We believe this is a useful indicator of our organic growth.
Regarding some key metrics that we discuss each quarter, on a year-over-year basis, our customer base grew by 7.5% to nearly 1.9 million customers; paid downloads grew by 6% to 45.2 million; revenue per download grew by 12% on a reported basis and 10% on a constant currency basis; our image library expanded by 41% to more than 204 million images; and our video library increased by 44% to 10.9 million clips.
As Jon mentioned earlier, revenues generated by our e-commerce business improved 11.6% to $91.7 million as compared to the prior year second quarter. And our enterprise business grew nearly 35% to $64.9 million in the quarter. International expansion and localization features and functionality continue to be a core part of our growth strategy. These features include improvements in local currency payment functionality, contributor workflow and our search algorithm improvements.
In the second quarter of 2018, approximately 67% of our revenues were from customers outside the United States. Of that amount, about half was derived from customers in Europe and the other half was from Asia-Pacific, Latin America, Canada and the Middle East combined.
Our operating expenses for the second quarter of 2018, excluding stock-based compensation, increased 1% versus the first quarter of 2018 and increased 17% versus the second quarter of 2017, driven primarily by investments we're making in both our infrastructure and our smaller but high-growth, high-potential businesses. Contributor royalty expense was approximately 26.8% of revenue, which is essentially unchanged from our recent historical experience.
Before I go into some of our major expense categories, I'd like to reiterate that we have taken and continue to take actions to reduce the growth of our expenses. We improved operating margins as we proceeded throughout the second quarter as well as having improved operating margins versus the first quarter of this year. Expense management is, of course, an ongoing effort that we believe will continue to yield improved results in the second half of 2018 and beyond.
As I discuss the expense categories, my comments will exclude stock-based compensation expense and they refer to variances between the second quarter of this year and the second quarter of last year. Sales and marketing expense increased 15%. Generally this category spend is split equally between marketing spend and the cost of our enterprise sales organization. As always, we work to improve the return on investment on the spend.
As a percentage of revenue, sales and marketing expense was relatively flat as compared to the first quarter of 2018 as well as compared to the second quarter of 2017. Product development costs increased 38% versus the second quarter last year, primarily due to higher personnel and consulting costs related to building a more expansive customer platform.
General and administrative expenses decreased by 13.5% from the first quarter of this year and increased 5% from the second quarter of 2017. As a percentage of revenue, G&A expenses were 13.1% as compared to 14.6% in the second quarter of last year. As I have stated in prior calls, we continue to work to improve our margin performance. The decreases in G&A this quarter show the early results of cost-cutting measures that have already been actioned and we continue to work to improve our margins throughout 2018.
Our effective tax rate was 81.8% for the second quarter and 24% for the six months ended June 30, 2018. Income tax expense decreased by $2.9 million for the three months ended 06/30/2018 as compared to the same period in 2017. The rate for the second quarter was driven higher primarily by a discrete item, which was the write-off of our investment in a content provider SilverHub Media. Excluding the discrete items of the sale of Webdam and the SilverHub write-off, we expect that the full year effective rate will be in the low-to-mid-20% range, which is consistent with our 2018 guidance.
Most important is that during the six months ended 06/30/2018, our cash taxes were actually a net tax refund of $124,000 as compared to net cash taxes paid of $3.3 million in the first half of 2017. The effective tax rate is based on the provisions of the Tax Cuts and Job Act (sic) [Tax Cuts and Jobs Act] (16:25) and our best estimate at this point of the impact of the relevant provisions of that act based on available information. We will continue to monitor additional information and implementation guidance as becomes available during the year.
GAAP net income in the quarter was a loss of $254,000, approximately $0.01 per diluted share, a decrease from net income of $3.1 million or $0.09 per diluted share in the second quarter of last year. The decrease in GAAP net income is due primarily to the loss of approximately $4.8 million or $0.14 per diluted share, which is net of tax related to the write-off of our long-term investment in SilverHub Media.
Adjusted net income was $10.7 million or $0.30 per diluted share for the second quarter of 2018, as compared to $8.3 million or $0.24 per diluted share in the second quarter of last year. Adjusted EBITDA for the second quarter was $24 million compared to $18.3 million last year second quarter. And total deferred revenue grew 3% year-over-year to $139.9 million of which approximately 41% relates to our e-commerce business and 59% to our enterprise business.
Moving to cash flows and the balance sheet, in the second quarter, we generated $16.9 million of cash from operations. Free cash flow was $8.2 million, a decrease of $1.9 million from the second quarter of 2017. Free cash flow includes cash payments for capital expenditures and content purchases. This change in free cash flow was primarily driven by decreased cash from operations, which was partially offset by decreases in capital expenditures as well as cash used to acquire content.
At the end of the quarter, we had approximately $290 million of cash and cash equivalents. As Jon mentioned earlier, we're pleased to announce that our Board of Directors has declared a special one-time cash dividend in the amount of $3 per share.
Our liquidity strategy has been to maintain a strong target cash position that enables us to fund operations while also providing us with the flexibility to consider a variety of operational and strategic growth opportunities to maximize shareholder returns.
The decision to pay the special dividend was based on several factors, including cash on hand of approximately $290 million, strong operating cash flow generation, confidence in our 2018 year to go (19:08) plan as well as our prospects for 2019, and $42.4 million that we received in net proceeds from the sale of Webdam. And lastly, that we, on a year-to-date basis, have made no cash tax payments.
The dividend will be payable on August 29, 2018 to stockholders of record on the close of business on August 15, 2018. The aggregate amount of payment to be made in connection with the dividend will be approximately $105 million. As we have done historically, we will continue to evaluate the appropriate use of cash generated in our business to maximize returns for shareholders.
As it relates to our 2018 financial guidance, our expectations for the full year of 2018 remain unchanged and we are reiterating our previously provided financial guidance for 2018. As a reminder, our guidance excludes the financial results for the two months in which we owned Webdam in the first quarter of this year. All of the guidance details are included in today's earnings press release.
As a reminder, the primary financial outcomes that we expect for 2018, which are, once again, detailed in today's release, a revenue of between $625 million and $635 million, representing growth of between 15% and 17% versus 2017; adjusted EBITDA between $105 million and $110 million, representing growth for between 19% and 25%. And once again, the adjusted EBITDA guidance excludes the gain we recognized on the sale of Webdam.
We appreciate your time today and your interest in Shutterstock. And now Jon and I will be happy to answer any questions you may have. Sonia, prompt the participants for questions.
Thank you. Our first question comes from the Youssef Squali of SunTrust Robinson Humphrey. Your line is now open.
Great. Thank you very much and good morning. Two questions for me. First, on your guidance, Steven, it looks like the second half, certainly to get even to the lower end of your margin guidance would imply a pretty strong acceleration in EBITDA or adjusted EBITDA margin and dollar amount. Can you just help us understand where most of that leverage should be coming from?
And on the top line, just generally speaking, it looks like the core business continues to do pretty well. As we look at this business beyond the 2018 and I was looking at 2019, you're going to have some FX headwinds that are going to be impacting the business. How sustainable is the double-digit growth rate in your mind as we go into 2019? Thank you.
So, thanks Youssef. As far as guidance in the second half, as we talked about for a couple of quarters now, as it relates to 2018, there are a number of factors that were costing us more money in the first half of the year – early part of the year that will decrease as we move throughout the year, our move to AWS, some of the other infrastructure efforts that we have. And from the fourth quarter of last year to the first quarter of this year and into the second quarter, we significantly reduced the external labor that we had previously as it related to our re-platform of our tech stack.
So there are a number of factors. While we report quarters, we actually are focused on not just the months but the days and we're very focused on that expense reduction. Taking that into account as with the growth that we have seen and continue to see, we feel confident that the levels of revenue and profitability in our guidance are achievable. So it's not just we need revenue to come through and expenses will (23:38) stay consistent, but once again, it's both the top line as well as the expenses.
As it relates to beyond 2018, we provide, obviously, the reported numbers as it relates to growth. We also provided the level of what I'll refer to as organic growth. We think that both our e-commerce business, which back in the latter part of 2015 and into 2016 had been decelerating and our e-commerce images business was really not performing well. The new platform has enabled us to do many things that have charged that growth forward and we continue to do those as Jon and I have highlighted in our comments. So we feel that double-digit growth is sustainable for quite some period of time at this point.
There's nothing that tells us differently. We're seeing very good utilization of the platform. We're seeing good customer growth. We're seeing good download growth, as we talked about, while it was relatively flat fourth quarter to first quarter, the second quarter increase in paid downloads was a healthy growth rate. So, we don't see indications of anything that would give us pause.
Okay. That's helpful. And then lastly, just on the dividends, which was somewhat of a surprise. How did you guys decide between dividend and what you've been doing so far, which is mostly doing buyback? And how much buyback is left on the books? Thank you.
So the buyback remains at about $100 million of capacity from the prior board authorization. And when it comes to dividends versus share repurchase, we looked at, of course, all of the relevant factors in terms of the timeframe in which we would do so, the impact of buying shares on our stock price relative to the daily available trading volume as well as the tax impact to our shareholders. When you consider the various changes in tax law, the difference between cap gains rate and the dividend rate is really, I don't want to speak for all our shareholders but for many, will not be materially different.
Got it. Okay. Thank you.
Thank you. And our next question comes from Brian Fitzgerald of Jefferies. Your line is now open.
Hey, good morning. Thanks for taking our questions. This is Alex Giaimo on for Brian. Maybe just first on the cost side, could you talk about the progress you've made in the infrastructure move to AWS? How far along you are there? And then maybe just some commentary around the GDPR regulation and any impact that's had on the business thus far? Thanks.
Yeah. So, let me take GDPR first. As it relates to GDPR, we have, of course, done all the work necessary to be compliant with GDPR and we're comfortable with where we are. I would not say it was – I know some folks have expected it to be disruptive to their business. We have not experienced that at all. And so, I think, while it was a level of work and, of course, required us to take certain steps, it has not been disruptive to our global business at all.
As it relates to the move to AWS, we're well along what I said was that we would have 150 basis points of margin impact that would decrease throughout 2018. We are on our plan. I don't have a specific percentage because at this point in time, what we're doing is, we're moving both infrastructure, we're moving certain application environments and yet we're still maintaining a hybrid cloud environment, where we'll have a good portion of our storage and things in a co-location. But a lot of activity will take place in the cloud. And once again, as a reminder, we've done this in a manner that gives us flexibility, so while we're very confident in the folks at AWS and the pricing that we're getting from them, we have done this in a way that gives us the flexibility to utilize other cloud providers in the future because we've done this with the technology that allows us to containerize it and move it around if necessary.
Okay. great. Thanks, Steven.
Thank you. Our next question comes from Ralph Schackart of William Blair. Your line is now open.
Good morning. Two questions if I could. On the e-com side of the business and the reacceleration, you talked about the new tech platform, pricing and some other sort of factors driving that. Was there one factor in particular that was a little bit more pronounced driving that or was it sort of just execution across all of the things you noted?
And then to Steven, you talked about potentially being able to sustain double-digit growth longer-term, but as we look at the margin structure now that you're working through, the AWS side and some other optimization around some of the OpEx. Can you give us some perspective or some thoughts about, perhaps, where you think long-term margins could go for the business? Thanks.
Sure. So as it relates to the factors driving e-commerce growth, there wasn't any single item there. Really, what has enabled it and enabled us to take these small steps, the pricing, the packaging, the A/B testing platform, the Editor usage by our customers and all of the components there, the localization that we have, the implementation of new payment platforms, all of those, which is we're implementing again (30:07), all of those have contributed to greater customer growth and very good traction.
I think, the other area – what enables all those things was the move to a new tech platform. So while those are all, I would say, execution, the real move to a platform that enabled the speed and productivity of our engineering teams and our product teams and really our marketing folks to really then drive the business was a key attribute to enable that.
As it relates to long-term margins, we talk about this and we believe that this business should and be able to run in the mid 20%, 25% margin. And we know there are other businesses out there similar to ours that run with adjusted EBITDA margins significantly higher than that and some lower, but we think that when we look at our cost structure, we look at the royalty structure that we pay to our contributors, the level of marketing. This business does generate higher margins with scale. We don't have incremental costs of our infrastructure each time we generate more revenue.
So, as we move to this more technologically savvy platform, move to AWS, we believe that we'll have continued improvement in margins for the foreseeable future, to get to that level. Like I said, there isn't anything that we see that's a blocker to us achieving that.
Great. Thank you.
Thank you. And our next question comes from Lloyd Walmsley of Deutsche Bank. Your line is now open.
Hey. Thanks for taking the question. It's actually Seth on for Lloyd. Just two if I can. First of all, can you talk about the strength in the enterprise business and where you're seeing the most uptick, is it existing clients expanding their spending, new clients or is it a good portion of this coming from Custom? And then can you also just tell us what percentage of enterprise is coming from Custom?
And then the follow-up would be, you called out strength from the British Royal Wedding and the World Cup, so just curious if you could provide any additional color on that? Thank you.
So as it relates to enterprise, Custom was not a material driver overall to the business on a year-to-date basis or in the second quarter but it has contributed some relatively minor amounts compared to the overall enterprise business. And it is an important piece of our offering as we go forward. It has lots of positive impact to many of the customers that we are serving in our enterprise business, as well as potentially new customers globally.
As it relates to new versus existing customers, we continue to both win new customers and have very good utilization. Our enterprise sales teams have performed well both in attracting new customers, but also our customer success teams have driven utilization, which is really important because it enables us when we're having renewal conversations to show the level of activity that they've had and the value proposition that it's delivering for our customers.
As it relates to the Royal Wedding and other activities, World Cup, that drive people to our editorial platform. While those – when you have events like those, it does drive people to the platform like the major media businesses and that enables them to be more connected to the platform and come back for other items. So it's not the event in and of itself while those are important events, they are really about what they do in terms of driving traffic. And so, they were great for traffic. They're great for people to see the updates and revisions we've made to the editorial offering and we have lots to come on the editorial side. So we feel really good about that. The number of events we covered, how we covered them and our client response has been overwhelmingly positive. So we feel like that's another lever for us to continue to push on.
Thank you. And, ladies and gentlemen, this does conclude our question-and-answer session. I would now like to turn the call back over to Steven Berns for any closing remarks.
I appreciate everybody's time today and we look forward to speaking to you next quarter. Thank you.
Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may all disconnect. Everyone have a great day.