Shutterstock's CEO Discusses Q3 2012 Results - Earnings Call Transcript

| About: Shutterstock (SSTK)

Shutterstock, Inc. (NYSE:SSTK)

Q3 2012 Earnings Conference Call

November 15, 2012 05:00 PM ET

Executives

Denise Garcia - ICR

Jonathan Oringer - Founder, Chief Executive Officer and Chairman of the Board

Thilo Semmelbauer - President and Chief Operating Officer

Timothy Bixby - Chief Financial Officer

Analysts

Scott Devitt - Morgan Stanley

Ross Sandler - Deutsche Bank

Sachin Khattar - Jefferies

Andre Sequin - RBC Capital Markets

Ralph Schackart - William Blair

Nat Brogadir - Stifel, Nicolaus

Operator

Good day ladies and gentlemen and welcome to the Third Quarter 2012 Shutterstock, Inc. Earnings Conference Call. My name is Diana and I will be the operator for today. At this time, all participants are in a listen-only mode, later we will conduct a question-and-answer session. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the call over to your host for today, Miss Denise Garcia, ICR. Please go ahead.

Denise Garcia

Good afternoon. Welcome to Shutterstock’s third quarter of 2012 earnings call. Joining me today to discuss our results are Jon Oringer, Founder, CEO and Chairman; Thilo Semmelbauer, President and COO; and Tim Bixby, CFO.

Before we begin I would like to take this opportunity to remind you that during the course of this call management will make forward-looking statements within the meaning of the Private Securities Legislation Reform Act of 1995 that are subject to various risks and uncertainties including predictions, expectations, estimates, and other information that may be considered forward-looking. Actual results may differ materially from the results predicted and reported results should not be considered as an indication of future performance.

Throughout today’s discussion we will present some important factors relating to our business, which may potentially affect these forward-looking statements. Listeners are referred to the reports and documents filed from time to time by us with the Securities and Exchange Commission including the section entitled risk factors in the company’s perspectives filed with the SEC on October 11, 2012. For a discussion of these and other important risk factors that could cause actual results to differ materially from those discussed in forward-looking statements.

We undertake no obligation to update publicly any forward-looking statements for any reason even if new information becomes available or other events occur in the future. In addition, as we refer to earnings, we will also refer to adjusted EBITDA which we define as income from operations before depreciation and amortization, non-cash equity based compensation, interests, and taxes. Non-GAAP net income which excludes the after-tax impact of non-cash equity based compensation and free-cash flow, which we define as our cash provided by operating activities adjusted for cash, interest income, and subtracting capital expenditures. Adjusted EBITDA, non-GAAP net income and free-cash flow are non-GAAP financial measures. You can find a reconciliation of these items to the most directly comparable GAAP financial measures in our third quarter earnings release, which is posted on the Investor Relations’ section of our website. We believe that the use of adjusted EBITDA, non-GAAP net income, and free-cash flow provide additional insight for investors to use in evaluation of ongoing operating results and trends. However, these non-GAAP financial measures should not be considered an isolation from or as a substitute for financial information prepared in accordance with GAAP.

Now I will turn the call over to Jon Oringer, Shutterstock’s Founder, CEO and Chairman.

Jonathan Oringer

Thank you, Denise, and thank you all for joining us. This is our first earnings call as a public company and I am excited to be updating our shareholders and the broader investment community about our performance. I am pleased to report that we had a strong third quarter, exceeding our topline and bottom-line expectations. We continue to see strong growth in all geographies and across all of our offerings as we execute our strategies.

On today’s call, we will describe the progress we have made in the third quarter and provide guidance for fourth quarter and 2013. As most of you know, Shutterstock is a global marketplace for commercial imagery. Businesses turn to Shutterstock for the imagery they need to sell their products and services. Our marketplace is driven by a virtuous cycle of content creation and consumption. When images are downloaded, contributors earn money and get a valuable feedback on what’s selling. As new content is uploaded, our library gets larger and customers come back to download more images. With one of the largest libraries of its kind, we deliver more than two paid image downloads per second. By the end of the third quarter of 2012 we had surpassed 215 million total downloads in our history. The more images we provide and faster that we can help our customers find the image they are looking for, the more customers we can attract. This is a cycle that drives our business and ultimately our financial results.

So, I will start with our quarterly operating metrics. Early in the quarter we celebrated an exciting milestone, when we added the 20 millionth image to our collection. We continue to add fresh content throughout the quarter approaching 22 million images by the end of September. In that same time period, we delivered nearly 19 million paid downloads and our revenue per download reached a record high of $2.26. This resulted in strong financial performance. Third quarter revenue grew 36% to $42.3 million from $31.2 million in the same period last year. Adjusted EBITDA grew 49% from $6.9 million in the third quarter of 2011 to $10.3 million in the same period this year. We are quite pleased with these results.

Now, let’s turn to some of our key accomplishments from the quarter. As you know, we made the transition to becoming a public company. We are thrilled to be operating in the public market and excited about the flexibility it gives us. As ever, we are focused on continuing to grow our share of the multi-billion dollar market for commercial imagery. Given that we represent a very small portion of the overall market, our primary focus is on customer acquisition, which Thilo will describe in more detail.

In addition, there are three strategic growth areas that are particularly important for us, international penetration, emerging content types, and large enterprises. All three areas have their own dedicated teams at Shutterstock and I will discuss our Q3 progress in each one.

Let’s start with international. Shutterstock is truly a global company. We currently sell our customers in more than 150 countries in 10 different languages, and our 35,000 contributors come from more than 100 countries. Since online marketing is an important growth driver for us, we continue to optimize the way that we reach customers across languages and geographies. This helps our marketing dollars to go further. We also continue to invest in localizing our proprietary search technology, so that customers can find the image they need no matter what language they speak. In Q3, we tested changes to our search algorithm in one of our key foreign languages and we saw meaningful impact on search success and conversion rates. We are currently in the process of rolling these changes out across other geographies. SEO is another incredibly important in complex challenge when we are dealing with 10 languages. We have spent years getting good at international SEO and in Q3 we took a few more steps forward in this area.

Now let’s turn to our second growth area, emerging content types. Video footage is our most important priority here. We see video content creation and consumption growing rapidly. As digital cameras that can take HD video continue to get cheaper, more powerful and more accessible, we have seen increasing number of video artists looking for ways to monetize their content. On the consumption side, with the increasing global broadband penetration and powerful mobile devices, taking advantage of 4G networks, we see websites using more and more video. Our footage business continues to grow more than 100% year-over-year. We continue (inaudible) as we have learnt in the nine years of selling still images to optimize the way that we source video and make it available to our customers. Our footage teams spent the third quarter improving video discovery and our video search algorithms, making sure that Shutterstock is the place to find the perfect for your needs.

Finally, let’s talk about large enterprises, a segment that is increasingly important for us. If you look at fortune 500 companies, over 70% of them already have at least one Shutterstock user. But the amount that these companies are spending with us is a small fraction of their overall image spend. In Q3, we ramped up our efforts to improve and increase the ways that we can meet the needs of large enterprise customers.

I am excited about the progress we have made in Q3 and the quarters and years ahead. With that I will turn the call over to Thilo who will walk you through our third quarter operational highlights.

Thilo Semmelbauer

Thanks, Jon. As Jon mentioned, our business is driven by strong network effects, more new customers and more repeat activity from existing customers drives more downloads, which generates more payouts to contributors. More payouts encourage contributors to give us more great content, which in turn drives more download activity. The cycle of activity also creates data that we use to optimize the website and our proprietary search technology. This is the virtuous cycle that drives our business and in Q3 our network effects continue to strengthen. We had 18.7 million downloads in Q3, up 26% from Q3 2011. This led to a record quarter in contributor payouts and while our content library is already the largest of its kind, our collection grew more in Q3 than in any other quarter in our history. We added over 1.5 million images of fresh content, 50% more than we added in Q3 2011, and we also added over 100,000 video clips in the quarter. We ended the quarter with over 21 million images and 700,000 video clips. The volume of content that we are attracting is exciting, but more importantly the quality and diversity of our new content is better than ever. One of the indicators we use is our image approval rate, which was unchanged in Q3, we continue to be picky and approve just over half of the content we receive.

On the marketing and sales front we made good progress in Q3, acquiring new customers efficiently and driving revenue. The bulk of our marketing and sales spend is focused on online marketing, and overall we spent $9.6 million in Q3, up only 13% versus Q3 2011. This spend drove revenue of $42.3 million, an increase of 36% from Q3 2011. We were pleased to see our cost to acquire new customers declined year-over-year. We achieved this through improved efficiency, through more testing and optimization, better localization of our campaigns in international geographies, and by adding new marketing channels. Online marketing is a constant balance of optimizing and testing. Some quarters we increased spend to test our new approaches, in other quarters we optimized faster than we were able to invest in new testing. In Q3, we found lots of places to optimize, allowing our marketing spend as a percent of revenue to improve nearly 4 points compared to the prior year. Going forward, we are likely to dial our investment in marketing backup to levels consistent with prior quarters.

This quarter, we also saw strong growth in both downloads and revenue per download. As in other recent periods, gains in revenue per paid download came primarily from product mix shift, as we held pricing for our various plans flat across our markets. On the sales side, where we are just getting started penetrating agencies and large enterprises, we had our best quarter ever. On the agency side, we signed our third global master service agreement with a large agency network, and we grew adoption and usage across all of our agencies. On the enterprise side, we signed more deals than ever and we also expanded our selling footprint by adding new team members in the US and Europe, including our first sales office outside of headquarters.

Now, finally, given that we are based in New York City, I want to provide a quick update on how Shutterstock faired during hurricane Sandy. We are proud to report that all of our customer and contributor facing websites operated without interruption, a great testament to our technology team and the contingency planning that has been completed over the last couple of years. I am very proud of the creativity and flexibility that our team has shown during this time.

With that, I would like to hand it over to Tim Bixby, our CFO, who will share some financial highlights from the quarter.

Timothy Bixby

Great, thanks Thilo. As a quick reminder, our non-GAAP financial measures do exclude stock-based compensation expenses, and we would like you to refer to today’s press release and the recent filings for the appropriate reconciliations.

Now, let’s review some of the key metrics for the quarter. As a quick review, number of paid downloads is 18.7 million for the quarter, this was up 26% from 14.8 million in the third quarter of 2011. Revenue was $42.3 million, an increase of 36% compared to the same quarter in the prior year. And importantly, in constant currency terms, our annual revenue growth rate in the third quarter would have been approximately 39%, about 3 percentage points better.

Revenue per download increased 8% to $2.26 as compared to $2.10 in the same period in the prior year. Important to note, that we have not increased our prices in several years. This increase in revenue per download as in past quarters continues to be driven by the mix and shift of the mix of pricing plans that our customers select. We have a higher effective price per download in certain pricing plans, particularly our direct sales efforts and our on-demand pricing plans, and those are growing faster than the overall business, and a little bit faster than our subscription downloads, and that has continued to cause the average revenue per download increase.

Adjusted EBITDA grew 49%, $10.3 million for the quarter, as compared to $6.9 million in the third quarter of 2011, a nice increase. Net Income was $8.7 million compared to $5.7 million in the third quarter of 2011. Diluted earnings per share, GAAP EPS, was $0.31 and this is on a pro forma basis for the share count including preferred shares. Please note that prior to our recent reorganization we had both common and preferred shares and I think we have given you a good amount of data in the press release to make sure you are getting what you need to understand the per share dynamics. Net income includes stock-based compensation expense of about $0.7 million in the quarter. This diluted EPS calculation for the third quarter is based on 28.5 weighted average fully diluted common shares. This does not include the impact of shares issued during the fourth quarter in relation to our recent initial public offering that happened just after the end of the third quarter. Non-GAAP net income in the third quarter was $9.4 million as compared to $6.3 million in the third quarter of the prior year. And non-GAAP net income, as we mentioned, excludes the after-tax impact of non-cash stock compensation expense.

Shifting to operating expenses, our cost of revenue was just above 38%. This was in line with prior quarters, and these cost of goods, as you may recall, are driven primarily by our contributor of royalty payments related to image downloaded by our customers. We expect our cost of revenue as a percentage of revenue, to remain stable in the coming quarter at between 38% and 39% of revenue.

Our total R&D expense was $4 million in the quarter, about 9.5% of revenue as compared to $2.8 million in the prior year. Our G&A expense, excluding non-cash equity-based compensation expense as a percentage of revenue, increased slightly over the same quarter in the prior year, from 6.2% to 6.7% primarily due to costs associated with our transition to becoming a public company.

Sales and marketing continued to show operating leverage over the prior year, improving by more than 4 percentage points, as we continue to find efficiencies within our marketing channels. While this was an improvement as compared to recent quarters, we expect that sales and marketing expense will increase somewhat as compared to the third quarter relative to revenue, as we continue to test new ways to spend incremental marketing dollars, while optimizing our existing marketing efforts.

In terms of overall headcount, we ended the quarter with 234 employees. This was an increase of about 35% from 173 at the beginning of 2012 and up 47% from 159 a year ago. And this is more or less in line with our overall staffing and growth goals. The breakdown of these headcount additions over the course of the year in three categories are as follows. About 40% of those additions were within our product and technology group, folks that sort of build products that we deliver to customers. About 40% in sales and marketing and the remaining 30% in our G&A area.

And now, I will turn to talking a bit about our expectations for the fourth quarter, just coming up, we are well into it, and the full year of 2013, some initial thoughts there. We are increasing our revenue and adjusted EBITDA expectations for both Q4 and for 2013. Please keep in mind the patterns of seasonality we have seen historically. During the fourth quarter, customer purchase activity typically decreases a little bit during the Holiday period in late November and late December, when our customer are typically working fewer days per week as compared to other periods of the year.

This pattern has been relatively consistent for several years, we expect it to repeat this year. For the past several years, as a result, purchase activity then typically increases as our customers return to work shortly after the New Year. As a result, for the fourth quarter, we have strong growth expectations. We expect revenue to grow to a level between $44 million and $45 million, and our expectations for adjusted EBITDA have also increased to what we expect to see between $9 million and $9.5 million in the fourth quarter. We estimate that fully diluted share count for the fourth quarter will be approximately 34 million and this will include the impact of our recently concluded initial public offering.

I would now like to highlight an interesting item related to stock-based compensation. It will be important for modeling purposes for the fourth quarter. Historically, since Shutterstock has operated as an LLC, with a value appreciation rights of our plans, this is similar to an option plan for an LLC to have company, we incurred both ongoing stock-based compensation expense related to a small number of employees, as well as deferred stock-based compensation expense related to grants to all employees.

So at the point of our conversion to a Delaware C Corporation in early Q4, on October 5th, some of the deferred, actually all of the deferred stock-based compensation expense related to these grants of equity to employees gets accelerating. This is pretty standard and typical, and now that we have all the information about the IPO and evaluation, we are able to provide this information ahead of the coming fourth quarter.

As a result, we expect that our Q4 results will include a stock-based compensation expense in the amount of approximately $8 million. Going forward, from Q1 2013, it’s important to note that we expect to have typical ongoing stock-based compensation expense each quarter, in line with other similarly situated companies. This amount for the full year of 2013 is expected to be approximately $7 million. So, in the fourth quarter, true-up due to our transition in reorganization and then in 2013, we will look very much like other similarly-situated companies.

A couple of other assumptions that we think will help you with Q4, and then we will talk about 2013. Amortization of intangibles approximately $0.3 million for the full year of 2012, stock compensation expense for the full year approximately $11 million, including the Q4 adjustment that I just spoke about, depreciation approximately $2.5 million, and effective tax rate and a cash tax rate in Q4 of approximately 43% and a CapEx, capital expenditures total spend for the year of 2012, we expect to be approximately $5 million.

If we combine our performance to date with our Q4 expectations would give you a full-year expectation between $164 million and $166 million, and an expected adjusted EBITDA for the year between $32.5 million and $33 million. Fully diluted weighted average share count for the year, we would estimate to be approximately $32 million.

Our expectations for revenue for 2013 have also increased, and we now expect revenue in 2013 of between $204 million and $208 million, and for adjusted EBITDA, we have increased that as well to between $44 million and $45 million. Fully diluted share count for the full year of 2013, we expect to be approximately 35.5 million shares. We expect total capital expenditures in 2013 of about $11 million, and this is made up of two pieces, this is also important to note, about $5 million of that is related to ongoing computer servers and network infrastructure, to really run the business and expand our operations to provide products to customers, and this is apples-to-apples with the approximately $5 million that we expect to spend in 2012. There is an additional $6 million that we have added to our expectation for next year, which is more of a non-recurring expense related to leasehold improvements we expect to incur, as we plan to relocate and expand our primary headquarters office in New York City. That is likely to happen, we expect now over the course of 2013. And so, we will expect to incur a capital expense related to that.

Just isolating the operating cash that drives the business, $5 million expected in 2012, $5 million or so expected in 2013. So, a nice improvement in the ratio of that CapEx to revenue from 2012 to 2013.

In summary, we are off to what I think is a very strong start as a public company, and we have just begun executing on the several growth opportunities ahead of us. Got a unique business with one of the largest content libraries of its kind, leading search technology and a business model that enjoys significant network effects. We are really excited about the feature and we look forward to long and productive relationship with our stockholders and also with our new equity analysts.

And with that, we will wrap up, and we would now like to turn it back over to the operator, who can rejoin the call, and we will be happy to take questions from the participants. Diana, if you could rejoin the call?

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Scott Devitt with Morgan Stanley.

Scott Devitt - Morgan Stanley

Hi, thanks for taking my question, I had two, please. First on the Q3 marketing spend continued to leverage based on the reasons that you laid on the call. And I am just wondering you mentioned that sales and marketing may go back to prior quarter levels, I think was the comment. I just wondered if you could talk about that in terms of how we should incorporate that from a modeling standpoint over the next few quarters. And then secondly, you mentioned also the headcount adds and particularly I think inside sales and engineering were two areas of focus more recently. How has that progressed and where do you think you are now in terms of hiring in those areas? Thanks.

Jonathan Oringer

Sure, so we hit the sales and marketing ratio first and we will do the headcount second. So, our sales and marketing, I think the results in the quarter were quite positive, in that we were able to drive significant growth, find a lot of efficiencies, but also the marketing spend drove more revenue growth in terms of ratio than we have seen in the past couple of quarters. So, a lot of things kind of came together and brought that number down quite a bit in terms of efficiency in Q3. I don’t think we will see, in our expectations, we will see that number bump up a little bit in the coming quarters. I would not expect it as high as you saw in Q2 and Q1, but I would expect it slightly higher than you are seeing today in Q3. So, that should give you a little flavor for how we are looking at it. Q3 was very strong performance, but we are biased as always towards investing more towards driving more growth. So, it will probably edge up somewhat but less than Q2.

Thilo Semmelbauer

Hi Scott, this is Thilo. I will take your headcount question. On the sales side, just to give you a feel for it, we don’t break it out, but direct sales makes up less than 10% of our revenue, but it’s growing much faster than our overall business. And if you look at our sales team, our headcount, it’s also less than 10% of our headcount, but again, that team is growing faster than the overall headcount. That’s on the sales side. I believe you had also asked about R&D headcount. R&D headcount is less than half of our total headcount and we do expect that to grow overtime. And it’s largely in line with historical levels.

Scott Devitt - Morgan Stanley

Thank you.

Operator

And your next question will come from the line of Ross Sandler, Deutsche Bank.

Ross Sandler - Deutsche Bank

Thanks guys. I also had just two quick ones. A follow-up on the marketing. So, Thilo, you mentioned some optimization, some efficiency. Can you just give us a little more color on where that was coming from, was it domestic, was it international, like, what is the tactics that are driving some of that efficiency and is it sustainable trend or do you think it was some efficiency found that may not persist? And was any of it driven by the higher mix of organic subs or was it primarily the marketing side? And then, Tim, can you just give us a little sense on the growth rate for on-demand versus subscription in the quarter? Thanks guys and good quarter.

Thilo Semmelbauer

Okay. On the marketing side, so, just to kind of explain the approach, the way we approach marketing, we are always trying to find new places to just spend cost effectively and we are always optimizing. So, it’s natural to see quarter-to-quarter fluctuations, but specifically for Q3, we had optimizations across our regions, looking at some of our less efficient channels, and moving some of that spend into more efficient channels. And again, our channels are search engine marketing, display advertising, we use re-targeting networks and lots of other channels as well. We also had some improvements to better localization of our campaigns, which is I think something that we have seen in the past, but we saw more of it in Q3.

Now, on the flip side, we also spent in some new channels that was additional spend, but net-net, we had a very efficient quarter, hopefully that gives you some of the color.

Timothy Bixby

Yes, and then in terms of the growth rates by pricing plan, again, we don’t break down exact metrics, but we saw continuation I think of trends we have seen over recent quarters. And what that has been generally is the subscription plan, pricing plan has grown a little bit more slowly than our overall growth, and on-demand growing a little bit faster, and that has continued to drive the mix shift, but we have seen consistent and steady growth from both overtime. We expect that to continue. In terms of outliers, I think direct sales and footage, video footage tend to be the ones that grow a fair amount faster than the overall business. So, that is also a trend that we expect to continue.

Ross Sandler - Deutsche Bank

Great, thank you.

Operator

Your next question comes from the line of Brian Fitzgerald, Jefferies.

Sachin Khattar - Jefferies

Hi guys. It’s Sachin sitting in for Brian. Two questions. The first is can you talk about the sort of the press release you guys put out recently, the Bigstock API program with CafePress and Emma, what’s really the kind of the monetization model then? And what else, going forward, if there is other sorts of partnerships you can do on that front? And then my second question is, you guys have sort of revenue per downloads sort of an inflation or increase for last several quarters. Going forward, are you thinking about pricing, increasing pricing, or are you going to kind of keep pricing consistent, get, you know, have some ability from emerging content formats for improvement in pricing? Thanks.

Jonathan Oringer

Yes, this is John, I will take that first question about the Bigstock API. So, we have gotten some demand over the years for companies that may have creative audience to link into our website in a more programmatic way so that they can sell images through their products directly. So, companies like Emma who, they do e-mail campaigns for creatives or CafePress where they put images on certain items, we sort of can create a pretty seamless for their customers to buy our images. So, as we start to see that demand, we implement the API and that’s why we do that.

Thilo Semmelbauer

And this is Thilo, I will pick up on the pricing point. As we have mentioned, we have held our pricing for our products flat over not only Q3, but really over the last few years, because our focus is really on increasing share. We are the significant price advantage to some of our competition and we believe that’s the right place for us to be right now. Long term, again, I think that we have talked about, there is probably opportunity, but we are very focused on increasing our penetration at this point.

Jonathan Oringer

Okay. All right, thanks a lot.

Operator

The next question comes from the line of Andre Sequin, RBC Capital Markets.

Andre Sequin - RBC Capital Markets

Thanks for taking my question and congratulations on a great quarter here. Just a couple of questions, also. First I wondered if you could give us a little color on any linearity you might have seen in the quarter. Clearly, we saw good strength throughout the quarter, but was there any acceleration or deceleration growth through the quarter that you saw that might be carrying through into 4Q, or perhaps any regions that were performing better or worse? And then secondly, in building out your international offering, how close are you to adding any new languages or currency options, or are there any other developments since the road show that you might call out? And I guess sort of, as a part of that, is there any significant pricing difference between international regions that could impact the revenue per download, if revenue in one country would grow faster or slower? Thanks.

Jonathan Oringer

Sure. We will take first ones first, and the selling/buying pattern. What we have seen in past years and what we saw again this year was sort of a sharp uptick in the sort of daily revenue run rate in the September and early October period, we have seen in prior years. It tends to hit relatively suddenly, but it has been a consistent pattern we saw it again this quarter. We have a lot of visibility we can see. 90% of our revenue in a given quarter comes from existing customers for whom we have a lot of data. So, it’s highly visible and highly predictable. So, we kind of saw what we more or less expected to see. Heading into the fourth quarter, I think because we exceeded our expectations, it definitely sets you up stronger for the fourth quarter. We typically don’t see revenue declines. We are always building every month and every quarter on a larger and larger base. So, it definitely sets us up strong for the fourth quarter. We expect a strong finish. We had that last year. So, this year, I think we will be in good shape.

Thilo Semmelbauer

On international, so Shutterstock has been an international company from the beginning. We have had languages – we have had the site translate into many languages, going back to 2007. We are always looking at new geos and trying to figure out where to put our resources and we are not ready to share any specifics right now, but as I mentioned before, one of the things that we did do over the past quarter was, and one of our geographies improved search, and we saw great things by just using all of the data we have with our millions and millions of downloads, our two downloads per second, we are able to take that data and really jump into geography and make it even much more localized. So, while we are looking at new geos, we also go back and constantly refine all of the languages we do sell in currently.

Andre Sequin - RBC Capital Markets

Great, thank you.

Operator

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

Ralph Schackart - William Blair

Good afternoon, good start guys. First question is related to outlook. Your 2013 outlook was stronger than our model. Can you remind us first, how you approach your guidance and the visibility you have into your annual outlook, and then how you balanced your 2013 outlook, given what’s been a little bit sort of a mixed bag from some of the agencies?

Thilo Semmelbauer

Yes, so, I think our outlook and optimism and confidence and visibility has not changed looking into 2013 and beyond. What did change I think is a strong finish and result in Q3, and sort of continued building the strength on that in early Q4. So, we are basically letting that roll through the future periods. If you look at the middle of the range, the mid-point of the range on revenue it’s right on the sort of 25% growth mark. So we are still confident in that number. We have obviously done better than that in recent quarters. We are cautiously looking to see what’s happening in Europe and with currency, those have been against us this year and we have delivered very strong performance despite that. So, those are starting to soften and improve a little bit. Currency is kind of flattish now, actually getting somewhat better. Over the past month growth rates in Europe have sort of stabilized. So, we are cautiously optimistic but we built the guidance so that when some of these key factors move against us and for us and shift around that we are comfortable we can still achieve the top and bottom line.

Ralph Schackart - William Blair

Great. One more if I could. Can you give us a sense of where do you think EBITDA to operate and cash flow conversion rates will be for ’13 or should they be similar to 2012? Given the recent IPO cash how are you thinking about cash deployment going forward as you start to generate a lot of free cash flow?

Timothy Bixby

Yes, so on the first one I think I would expect a similar pattern of conversion going forward. The only couple of things I would highlight, we mentioned a non-recurring CapEx item obviously that will hit cash, that’s not something we expect year in and year out, it’s a one time and we expect this year. It also highlight our transition from close to zero tax rate as an LLC to a full tax payer in Q4. But absent those adjustments which I think you have taken account of I would expect a similar conversion rate.

Ralph Schackart - William Blair

And then in terms of the IPO and free cash flow?

Timothy Bixby

Yes, in terms of the IPO cash, I mean the key is there about the IPO, a really important branding effort for us, we are just starting to see the benefits of that as we expand both in the US and outside the US. That’s a really important piece of it. The strength of the balance sheet being able to go into very large companies and convince them that we are the best option for them on price and value and stability as a company, that’s a winner and having that strong balance sheet is important. And they were also always looking for growth opportunities, organic growth opportunities are significant. It’s a pretty good list of things we are going after, but if we see opportunities to accelerate that at the right valuation we will take advantage of the – a little bit of the cash in the balance sheet and then also the public equity to move quickly on those opportunities.

Ralph Schackart - William Blair

Okay. Thank you.

Operator

And your next question comes from the line of Nat Brogadir with Stifel, Nicolaus.

Nat Brogadir - Stifel, Nicolaus

Hi, guys, thanks for taking my question. Two quick ones. First housekeeping, the 8 million of stock comp, is that going to flow 100% through G&A from a GAAP basis. And then secondly, if you look at the margin guidance, EBITDA margin adjusted 20% to 21%, you guys really just up sided the 3Q at 24% EBITDA margins, so it looks like sequentially cash OpEx is increasing some $3 million or $4 million. I am wondering what line items we should be thinking about that increase excluding the 8 million stock comp? Any thought guys?

Timothy Bixby

Yes, so on the stock comp will be pushing that through each of the line items, so it will be spread based on our employee base, which obviously it hits each of the line items, not just in G&A. In terms of headcount, a significant proportion of our headcount, probably 40% plus is in the R&D and product category, another 30% plus in sales and marketing, so you will see the bulk of it below the gross margin line, but there might be a small amount above the gross margin line. And then in terms of EBITDA, the most leverage I think will come from where you have seen it in recent quarters in terms of pull up and down is sales and marketing. Our G&A expense will step up as you have seen a little bit due to the public company costs and infrastructure costs, that will scale a little bit more going in 2014 and beyond. Sales and marketing will be the key driver and I think that’s why we encourage you not to model or extrapolate the Q3 rate forward. But somewhere that’s a little more conservative because we do have places to spend that.

Nat Brogadir - Stifel, Nicolaus

Excellent Tim.

Operator

Ladies and gentlemen, this concludes the question-and-answer portion for today. We would now like to thank everyone for their attendance and participation in today’s call. You may now disconnect and have a great day.

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