Shutterstock's CEO Discusses Q4 2012 Results - Earnings Call Transcript

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Shutterstock (NYSE:SSTK)

Q4 2012 Earnings Call

February 21, 2013 05:00 pm ET

Executives

Jon Oringer – Founder, Chairman & Chief Executive Officer

Thilo Semmelbauer – President & Chief Operating Officer

Tim Bixby – Chief Financial Officer

Denise Garcia – ICR

Analysts

Ross Sandler – Deutsche Bank

Zach – Morgan Stanley

Nat Brogadir – Stifel Nicolaus

Ralph Schackart – William Blair

Brian Fitzgerald – Jefferies

Andre Sequin – RBC Capital Markets

Youssef Squali – Cantor Fitzgerald

Operator

Good day, ladies and gentlemen, and welcome to the Q4 and Full-Year 2012 Shutterstock Earnings Conference Call. My name is Keith and I’ll be your operator for today. (Operator instructions.) As a reminder, today’s conference is being recorded for replay purposes. With that I’d like to turn the conference over to your host, Ms. Denise Garcia of ICR. Please go ahead.

Denise Garcia

Good afternoon. Welcome to Shutterstock’s Q4 and full year 2012 earnings call. Joining me today to discuss our results are Jon Oringer, Founder, CEO and Chairman; Thilo Semmelbauer, President and Chief Operating Officer; 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 may make forward-looking statements that are subject to various risks and uncertainties including predictions, expectations, estimates and other information. Actual results may differ materially from the results predicted and reported results should not be considered as an indication of future performance.

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 latest 10(q) filed with the SEC on November 20, 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 our earnings we will refer to adjusted EBITDA which we define as income from operations before depreciation and amortization, non-cash equity based compensation, interest, and taxes; non-GAAP net income, which excludes the one-time benefit related to the company’s reorganization, non-cash equity compensation expense and the tax benefit for deductible non-cash equity compensation; and free cash flow, which we define as cash provided by operating activities adjusted for cash, interest income, and expense and less 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 Q4 and full year 2012 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 the evaluation of ongoing operating results and trends. However, these non-GAAP financial measures should not be considered in isolation from or as a substitute for financial information prepared in accordance with GAAP.

And now I’ll turn the call over to Jon Oringer, Shutterstock’s Founder, CEO and Chairman.

Jon Oringer

Thanks, and thank you all for joining us for our Q4 and full year 2012 earnings call. I’m pleased to report another strong quarter where we exceeded our top line and bottom line expectations. We continue to see strong growth in all major geographies and across all of our offerings. On today’s call we will describe the progress we made in Q4 and 2012 and provide financial guidance for Q1 and full year 2013.

Let’s begin with our key operating metrics download volume and revenue per download. Every download is a business licensing an image on our platform. When businesses choose Shutterstock to license images and video, contributors earn money and receive feedback on what’s selling. This motivates contributors to upload more content which increases the breadth of our library and in turn helps us to attract new customers and to foster their loyalty. This is a virtuous cycle that drives our business and ultimately our financial results.

So in Q4 we have proudly delivered a record 21.4 million downloads. Our revenue per download reached a new high of $2.30 and our collection grew to more than 23 million images and video clips, making it one of the largest libraries of its kind. Our strong operating results drove record financial performance. Q4 revenue grew 42% year-over-year to $49.2 million. Adjusted EBITDA grew 54% to $11.3 million in Q4 2012. We finished the year with revenue of $169.6 million representing 41% growth over the prior year and we achieved this growth while delivering adjusted EBITDA of $34.9 million.

Alongside this outstanding financial performance we continued to make excellent progress on our three growth strategies, which are increased global penetration; emerging content types; and large enterprises. Let’s spend a moment on each of these, starting with global penetration.

Given that we represent a small portion of a multi-billion dollar market for commercial imagery, we continue to focus on aggressive customer acquisition. While we have seen strong growth in all major territories we have placed a particular emphasis on the international localization and marketing.

In Q4 we launched four additional languages – Hungarian, Czech, Turkish, and Polish – bringing the total number of languages we support to 14. We also began accepting Australian Dollars, our [nice] currency, and we continued to innovate on our search algorithms to better serve customers around the world no matter what language they speak. We are excited about the early results we have seen and we’ll continue to focus on global penetration as a core theme in the upcoming quarters.

Moving on to our second growth strategy, emerging content types, video footage continues to be the priority in this area and we made impressive progress in Q4. Our video collection grew at a record pace to more than 800,000 clips while video revenue continues to be one of our fastest growing product categories.

Finally, as our third area of strategic focus we continue to expand our direct sales effort to large enterprises. As you may recall, over 70% of Fortune 500 companies already have at least one Shutterstock user account. However, the amount that these companies are spending with us is still just a small fraction of their overall spend.

Our direct sales team continued to make impressive progress in Q4, closing key master service agreements with large agencies and publishers and steadily growing direct sales revenue. We’re excited about the progress we have made with large enterprises during the quarter and look forward to expanding our relationship with these larger companies over time.

Reflecting on 2012 we achieved a number of significant milestones. We started 2012 as a private company and during the course of this year we completed an initial public offering, recruited a world-class Board of Directors, and strengthened our team to support continued growth. Additionally, we delivered on our revenue and profitability goals, increased the number of paying customers to more than 750,000 and added more images to our collection in 2012 than we had in total as recently as 2008.

We are excited about all that we’ve accomplished during the year, the progress we’ve made towards our goals and the opportunity ahead. And with that I’ll turn the call over to Thilo who will detail some operational highlights.

Thilo Semmelbauer

Thanks, Jon. We are keenly focused on providing value to both sides of our global marketplace – contributors and customers – and are proud of the many accomplishments we had in Q4 and the full year 2012. Starting with contributors, we continue to focus on increasing the size, quality, and diversity of our content library. Looking at the stats we had a record quarter in contributor payouts and our collection grew more in Q4 than in any previous quarter. We added 1.6 million images and more than 100,000 video clips in the quarter, and ended the year with 23 million images and 800,000 video clips.

We continue to invest in initiatives to support this growth. For example, in Q4 we produced a comprehensive success guide to help new and existing contributors create high-quality stock imagery, which has gotten great feedback. We also launched contributor profile pages so that our customers can easily follow and keep track of the latest content from their favorite contributors.

On the customer side of the marketplace, we know that finding the right image quickly is a major reason customers choose Shutterstock. Search is a key competitive advantage and we continue to make improvements that leverage the high volume of data our users generate. One improvement we made in Q4 has reduced the number of times customers get zero search results. By interpreting the user intent and making more intelligent recommendations, we’ve been able to improve the experience significantly.

We also continue to optimize our search results for different languages. During the quarter we made progress in several languages, leading to improved conversion and usage in those languages. These types of changes can have a significant impact on our conversion rates over time which allows us to lower our costs to acquire new customers and increases marketing efficiency.

We also continued to expand our mobile offerings in Q4. We already have an award-winning iPad app and in Q4 we launched Shutterstock for iPhone. Even though most of our customers are using Shutterstock at work it’s now easier than ever for them to access Shutterstock 24/7.

We were pleased with the results of our marketing activities in Q4 as we continued to improve efficiency as well as expand in new channels. The bulk of our spend continues to be online marketing. Overall across marketing and sales, and excluding stock-based comp, we spent $11.2 million in Q4, up 17% versus Q4 2011.

These activities drove a 42% increase in revenue from Q4 2011 while our cost of acquiring new customers remained stable as we increased spend and improved efficiency through more testing and optimization, better localization of our campaigns across geographies and the addition of a new marketing channel. We have high confidence that we took a step forward in gaining market share in 2012.

From a branding perspective, our goal is to be top-of-mind for any business that needs licensed imagery. Based on new research we conducted in Q4 with the help of a leading brand research firm in five [marked] top countries, we see significant opportunities to increase users’ awareness of our brand. This research gave us added confidence to continue investing aggressively in marketing and reinforced how much untapped opportunity there is for us in the multi-billion dollar market for commercial imagery.

We continued to manage our marketing spend by balancing, testing, and optimization. Some quarters we increased spend to test out new approaches; in other quarters we optimized faster and then were able to invest in new testing. So we will continue to see quarter-to-quarter fluctuations.

Our direct sales team continued a strong trajectory, delivering a record quarter. Direct sales continues to be one of the fastest growing areas of our business. We’re especially pleased with our large agency sales which are gaining promising momentum, and in the quarter we continued to add sales personnel in key markets. In the US we added new hires in Los Angeles, Chicago, and New York.

So as we look back on the full year of 2012 I’m proud of the progress we’ve made across the entire business. We added more images than ever before, 5.5 million to our collection, which continues to be one of the largest of its kind. We made it easier to get to the right image through innovation in search, discovery tools, and mobile with an award-winning iPad app and a new iPhone app. We invested in our contributors with improved contributor signup, profile pages, and our success guide; and we scaled up marketing and sales efficiently, driving both growth and profitability.

So we enter 2013 well prepared for growth and I’m excited about the year ahead. I’d now like to hand it over to Tim Bixby, our CFO, who will share financial highlights.

Tim Bixby

Great, thanks Thilo. We’ll now review a little more detail around some of the operational and financial metrics and then we’ll be happy to take questions at the end. As a quick review, the number of paid downloads was 21.4 million for the quarter, a key operating metric for us. This was up 32% from 16.2 million paid downloads in Q4 2011. Revenue overall was $49.2 million, an increase of 42% as compared to the same quarter in the prior year. On a constant currency basis growth would have been two percentage points better, or 44% year-on-year growth.

Revenue per download also showed a nice increase, increasing 7% to $2.30 as compared to $2.14 in the same period a year ago. This increase in revenue per download as in past quarters continues to be driven by the mix of pricing plans that our customers select. We have a higher effective cost per download in certain pricing plans, particularly our direct sales efforts to larger customers and our on-demand plans both of which are growing faster than the overall business, and that has continued to cause the average revenue per download to increase over time.

Note that we have not raised prices for several years and that this shift is due solely to mix shift. Notably, if we look only at incremental new customer revenue the split between on-demand and subscription is quite balanced, roughly 50/50.

Adjusted EBITDA grew 54% to $11.3 million for the quarter as compared to $7.3 million in Q4 2011, primarily the result of increased revenue but also due to increased efficiencies in marketing investment. Net income was $29.0 million compared to $5.8 million in Q4 2011. The diluted earnings per share result was $0.88.

This net income, it is important to note, includes the impact of a non-recurring tax benefit of $28.8 million related to our conversion from an LLC to a C-corporation on October 5th. Net income includes stock based compensation expense of about $7.6 million in Q4. The diluted EPS calculation for Q4 is based on a fully diluted weighted average share count of 32.7 million shares.

Non-GAAP net income in Q4 was $6.6 million as compared to $6.5 million in Q4 of the prior year. Non-GAAP net income excludes a one-time tax benefit related to our reorganization, excludes non-cash equity-based compensation expense and the tax benefit for deductible, non-cash equity-based compensation.

Looking at the full year 2012, revenue was $169.6 million, an increase of 41% compared to the prior year. On a constant currency basis again, full year revenue would have increased 43% or approximately two percentage points better. Adjusted EBITDA grew 32% to $34.9 million for the year as compared to $26.5 million in 2011. Net income was $47.6 million compared to $21.9 million in 2011 and this includes as well the nonrecurring tax benefit. Fully diluted earnings per share was $1.79. This is based on a fully diluted weighted average share count of 23.8 million shares. Non-GAAP net income for 2012 full year was $28.0 million as compared to $24.0 million in 2011.

Now we would like to give you a little more color on the geography breakdown of our revenue. For the full year approximately 35% of our recognized revenue came from North America, about 37% from Europe and about 28% from the rest of the world. If we compare this to the prior year there was a very small shift in share from Europe to the rest of the world but only a couple of percentage points, so a fairly stable split across the world. Growth by region has been stronger in North America and the rest of the world, well above 40% year-on-year while Europe grew in the low 30% range. But in constant currency terms, Europe is growing nicely as well in the mid-30% range.

Let’s now turn to the expense lines. One thing to note, all expense line items do include non-cash equity-based compensation costs for the first time. Prior to our conversion to a public company in Q4 only G&A expense included stock compensation expense. Going forward all four expense lines will include this cost, and we’ve also provided the breakdown of the amount of stock compensation expense within each line within our press release.

Shifting to operating expenses for Q4, our cost of revenue was 38% and this was in line with prior quarters during 2012. Cost of revenue is made up of primarily contributor royalty payments related to image downloads and we expect this cost of revenue as a percentage of revenue to remain fairly stable in the coming quarters at between 38% and 39% of revenue. And this includes stock compensation charges which are minimal in the cost of revenue line.

Total R&D expense was $5.7 million in the quarter or about 11.5% of revenue as compared to $2.7 million in the prior year. If we adjust this expense line for stock compensation expense, R&D as a percent of revenue is about 8.1% as compared to 7.8% in the prior year, so a very slight increase relative to revenue. And we expect R&D as a percent of revenue to be at these similar Q4 levels into 2013.

G&A expense excluding non-cash equity-based compensation expense increased as compared to the same quarter the prior year from 8% to 10% of revenue and this is primarily due to costs associated with our transition to becoming a public company as well as higher non-income tax accrual rates in the quarter. We also expect G&A as a percent of revenue to be at similar levels as we head further into 2013.

Sales and marketing continued to show operating leverage over the prior year, improving significantly relative to revenue as we continued to find efficiencies within our marketing channels. Sales and marketing as a percent of revenue decreased to 23% from 28% in the prior year excluding stock compensation expense. We expect sales and marketing as a percent of revenue also to be at similar levels into 2013 as we saw in Q4.

In terms of overall headcount we ended the year with 238 employees. This is an increase of about 38% from 173 at the beginning of 2012. The breakdown of these headcount additions represent where we are investing in people, and over the course of the year were as follows: about 50% of the adds were within our sales and marketing groups about 30% were within product and technology, and about 20% within our G&A area.

I’d now like to provide a little bit more detail on our perspective Q1 2013 results for the first time and update our full year 2013 financial expectations. For Q1 we have strong growth expectations. We expect revenue to grow to between $48.5 million and $50.5 million. The midpoint of this range would put us at roughly 32% annual growth versus the prior year. We expect adjusted EBITDA between $9.0 million and $10.0 million in Q1. We expect that our Q1 results will include a stock-based compensation expense in the amount of approximately $2 million. This amount for the full year of 2013 is expected to be approximately $8 million. And we expect an effective tax rate of approximately 40%.

We are increasing our revenue expectation for the full year 2013 from $204 million to $208 million previously to between $213 million and $219 million for the full year. And we’re expecting adjusted EBITDA for the year between $44.0 million and $46.5 million. We also expect total capital expenditures in 2013 of approximately $11.0 million and this is made up of two key components - $5.0 million in capital expenditures is related to ongoing computer servers and network infrastructure to run the business and expand our operations and to provide products to customers. And this is apples-to-apples comparison with the approximately $4.0 million we spent in 2012.

There is an additional $6 million included I our expectation for the coming year and this is related to leasehold and other capital expenses as we plan to relocate and expand our headquarters office in New York City to support the continuing growth of the company. The operating portion of our capital expenditures excluding the nonrecurring real estate-related costs remains right around 2% of revenue.

In summary we closed another strong quarter and a strong year and we’ve just begun executing on several growth opportunities ahead of us. We have 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’re very excited about the coming year and the future. With that we’ll wrap up, and we’d now like to ask the operator if he’d rejoin the call and we’d be happy to take questions from the participants.

Question-and-Answer Session

Operator

(Operator instructions.) Your first question is from the line of Ross Sandler with Deutsche Bank. Please go ahead.

Ross Sandler – Deutsche Bank

Hey guys, nice quarter. Just a couple questions. First, you talked about the conversion rate improvement that you’re seeing from the local language stuff. Can you just quantify that at all? What kind of uptick do you see when you go into a new market with a local language? Second question is are you also seeing any conversion rate improvement happening in the US from some of the design issues you talked about? And then lastly, it sounds like the direct sales initiative is ramping nicely. Can you just also talk about the opportunity for that piece in markets outside of the US? Like which markets do you think it’ll work in and when does that rollout actually happen? Thanks.

Thilo Semmelbauer

Hi Ross, it’s Thilo. I’ll maybe take the first piece of your question, we’ll sort of go around. I think when we launch a new language on our site that’s obviously just one piece of the puzzle in our strategy to make our site and our content more relevant to increase penetration in our markets. So the way we think about it, it’s one step.

We need to, in addition to having the local language mobilize our marketing in those countries, make sure we have the right content and make sure that the search experience is providing the right content for our customers. So it’s a lot of things that come together and really the language rollout and the search improvements are part of a longer term strategy to optimize the site. It’s something that doesn’t by itself have a significant input without all the other things coming together.

The second part of your question I believe was around design issues, but you may need to clarify because I’m not sure I followed that one.

Ross Sandler – Deutsche Bank

I just want to know are you seeing also conversion rate lift in the US market from some of the things that you’ve been working on.

Thilo Semmelbauer

Yeah, we’re always testing different things on the website, whether it’s buttons or a language and pricing pages and configuration – so that’s part of an ongoing process. When you look at our marketing spend as a whole and the fact that we were able to in Q4 increase spend significantly while holding our efficiencies, that all the conversion improvements are flowing into that as well.

Jon Oringer

Yeah, and I think a good metric to look at is probably the growth rate overall in North America. That’s really driven by the US, and we’re seeing growth rates that are well above the overall growth rate of the company. So even though it’s our most established territory we’re still seeing very strong growth, and that means both the existing users are continuing to recur at a high level but also conversions are also improving in the US.

In terms of the direct sales opportunity, it is definitely US-focused now and we’re making really great traction but some of the master service agreements are with global agencies. And so we’re already making inroads with multinational groups that have subdivisions in the US and in many other territories. We’re also seeing some good traction in Germany and other European territories and that’s probably where you’ll see the first inroads. It’s where we have people on the ground for the first time in the last couple of years and so I would expect to sort of roll out that way.

Ross Sandler – Deutsche Bank

Great, thanks guys.

Operator

Your next question is from the line of Scott Dewitt with Morgan Stanley. Please go ahead.

Zach – Morgan Stanley

Hey guys, it’s Zach calling in for Scott. Just wanted to know if you can give us a little more detail on how you think about the revenue and EBITDA guidance – how do you think about it internally and then how do you maybe modify it for the street and what kind of confidence integral do you have in that?

Tim Bixby

So I think we’re highly confident we can achieved these numbers. Our philosophy hasn’t changed. We’ve got a quarter under our belts as a public company but we’ve obviously been setting these expectations and measuring ourselves against them for many years so that really hasn’t changed. It’s the external communication that is now an added piece of it. So we have great visibility into the current quarter obviously – we’re halfway through.

We have strong visibility into Q2 and then as we go through the remainder of the year we’re really relying on what are very established annual trends. So if you look at the last three years you see an annual cycle that’s consistent as the months of the year roll out. So we’re really relying on a lot of data that we now have and the year-to-date numbers support that confidence.

One thing to note is that when we grow at a 40% or plus rate that means that a lot of things have gone right. It means currency is not too much of a headwind, it means that nothing radical has changed in the search spend market, and it means that we’re continuing to find new marketing efficiencies. All those have happened over the last couple quarters. We can’t rely on that happening every quarter into the future but that’s certainly our internal goal.

Zach – Morgan Stanley

Great, thanks guys.

Operator

Your next question comes from the line of Nat Brogadir with Stifel Nicolaus. Please go ahead.

Nat Brogadir – Stifel Nicolaus

Hey guys, thanks for the time, nice quarter. Quickly on the paid downloads, that accelerated pretty nicely on a year-over-year basis. Can you just talk about why you think that is? Is it the international expansion? Is it North America? I think the revenue per download seems to be coming in line but you guys are certainly beating expectations on the paid download. What’s the driver there?

Thilo Semmelbauer

So there’s a couple of drivers. Obviously mix can drive it, so as we continue to see a shift to on-demand it’s a lower unit number but it obviously drives the revenue per download up. Subscription usage can accelerate in Q4 as we sort of head into the later part of the year, and I think we saw a surge in usage that drove the downloads up as well. So again, a lot of things kind of came together even ahead of our own expectations in Q4 on a volume basis.

We are investing from a marketing perspective in pretty much every territory in creative ways, and I think we’re just finding more and more of the niches where we’re able to convert more and that’s helped to drive the volume up.

Nat Brogadir – Stifel Nicolaus

Great, thanks. And just one follow-up: now that you guys have over $100 million in cash and are generating free cash, how do you think about the balance sheet and returning capital to shareholders?

Jon Oringer

Yeah, so we had a term loan. We paid half down; we’ll pay the rest down, we’re kind of keeping the balance sheet pretty clean. $100 million is a good base number. We’re obviously generating a fair amount of cash. We’re looking at ways to continue to invest. We like to have a little cushion. One of the things where we go in and talk to very, very large global companies now and they like to know that Shutterstock is as strong as the strongest companies in the world, and having a strong balance sheet is part of that conversation.

We also take note that although we’re growing very rapidly, if we see an opportunity to grow inorganically we have cash on the balance sheet, we have a public equity – that’s also something that we would take advantage of if it made sense.

Nat Brogadir – Stifel Nicolaus

Great, thanks guys.

Operator

Your next question is from the line of Ralph Schackart with William Blair. Please go ahead.

Ralph Schackart – William Blair

Hi, good afternoon. Tim, if I can start off and ask another question on the 2013 outlook. What sort of drove the boosted outlook on this call vis-à-vis last call? Obviously you raised the guidance. And too, if you can give us some perspective on what the annual retention rate was in 2012 and how that compares to 2011, thanks.

Tim Bixby

Yes, on the retention side we’re seeing very consistent metrics where we’re able to retain essentially 100% of our revenue from year to year so we haven’t seen any real shift in that. Average revenue per customer, lifetime value and all those kind of basic measures remain quite consistent. So that gives us a lot of confidence. One of the things, you know, when you see these annual patterns repeat year-over-year it gives you a little more confidence into the coming year of seeing that same trend.

So just sort of as a reminder, we have two surge points of the year – the early part of the year and then again in September. And those we just saw some nice results again in 2012 and if you roll that forward with a good November/December result that enables us to put out some numbers that we’re very confident in.

Ralph Schackart – William Blair

Great, thank you.

Operator

Your next question is from the line of Brian Fitzgerald with Jefferies. Please go ahead.

Brian Fitzgerald – Jefferies

Thanks, guys. You talked a bit about the record pace of growth for video footage into the library. Can you talk a bit about maybe the dynamics around the usage that you’ve seen around the new formats? And then internationally, is there a difference between what you’re seeing in terms of the various markets around those same dynamics – what’s going into the library and the usage of the newer formats? Thanks.

Thilo Semmelbauer

This is Thilo. Obviously our footage business is doing great. We’ve talked before about it’s essentially doubling and we’ll continue to see that trajectory. We continue to build out the collection and that’s coming from all geographies of the world, and we have a nice geographic diversity in our footage sales as well. We’re very focused on improving, continuing to improve the site and the search experience and we’re very pleased with our performance so far.

The formats, you know, I would say as you probably would expect the higher definition formats are gaining more and more traction. And I think we see the same thing on the image side as we see on the video side – that pixel count matters and there’s high demand for more and more of that. So that was consistent in Q4 as it has been in recent quarters.

Jon Oringer

Another couple good dynamics to keep in mind around footage is it tends to be a lower volume per user and a much higher price point. And the buyers are tending to use it much more in relation to motion videos, so a movie studio, a television studio, production companies. West Coast activity has been an interesting area for us. So it’s a real different dynamic economically, volume and price, but overall it’s very similar to the core business. So that’s why it’s really a promising area for us and we’re continuing to invest more in it.

Brian Fitzgerald – Jefferies

Great, thanks.

Operator

Your next question is from the line of Andre Sequin with RBC Capital Markets. Please go ahead.

Andre Sequin – RBC Capital Markets

Great, thanks for taking my question. I was wondering how do you think about then the approach to pricing on your enterprise contracts? Do you feel you have to give them a pretty big discount and if so, are you able to flow any of that through to your contributors? And then you guys are projecting a 40% tax rate for the year. With all the revenue you earn overseas do you expect you’ll be able to take advantage of some of the lower tax rates in any of those jurisdictions going forward?

Thilo Semmelbauer

Let me take those in order, this is Thilo. On direct sales, as you know our price points range widely in direct sales depending on the licensing terms, the indemnification terms and other features. We can be in the $10’s per image up to the $100’s per image. Discounting is very common obviously in all direct sales but we have significantly higher price points obviously there than in the core business, which is the ecommerce side.

And as our contributors are paid in percentage terms, if there are discounts that will flow through to the contributors as well but the higher price points flow through to the contributors. And actually we’re getting great feedback on what they’re starting to see in terms of their payouts, much higher dollar per images.

From a tax perspective, that’s obviously an area where we have the benefit of real revenue and real earnings in all territories of the world – 70% of revenue and essentially the same ratio of profits outside the US so that’s an opportunity for us. And we are looking at ways to synch up our earnings and our tax rates with the appropriate jurisdictions.

For this year our estimate is that our effective rate will remain essentially where it is but obviously that’s an opportunity that we’re working on internally; and as we get more information about when that’s likely to roll into the numbers we will certainly share it. But at this point that has a little bit of lead time on it.

Andre Sequin – RBC Capital Markets

Okay great, thank you. Nice quarter.

Operator

Your next question is from the line of Youssef Squali with Cantor Fitzgerald. Please go ahead.

Youssef Squali – Cantor Fitzgerald

Alright, thank you very much. A couple questions. I guess if I looked at the new guidance it implies about a $10 million increase to the top line at the midpoint with virtually no flow through to the bottom line – I think it’s about $1 million. I was wondering if you can maybe elaborate on that a little bit. Is there an increase in OPEX planned because I think your comments on gross margin seem to insinuate that gross margins should be relatively flat? And second, if I look at the ratio of paid downloads to the number of images added to the library on a sequential basis I think this was your strongest quarter ever or at least in a long while. So I’m trying to understand the reasons for the strong conversion and maybe as importantly, is there anything there that would make it not sustainable going forward? Thanks.

Thilo Semmelbauer

Yeah, I’ll take a crack at both of those. So on the operating expense side, we do expect cost of revenue and royalties to remain essentially static, so no real change there. The two areas that in Q1 we expect to sort of drive a flattish EBITDA even though revenue we expect to increase – G&A has stepped up a little bit, so as we expand our headquarters operation and have added headcount here those costs have gone up slightly. Public company readiness costs are going to be a little higher and then we’re also accruing at a slightly higher tax rate.

So some sort of non-operational items are escalating in the early part of this year and that’ll be essentially flat through the year. And then marketing we tend to spend a little bit more earlier in the year. We’re again, always looking for opportunities to spend more but that’s an area where you know, the sooner you get folks in before the later part of the year the better; and those two areas will drive most of it.

Jon Oringer

On the images added and paid downloads, it’s a very interesting question – I would go back to the network effects from the business, because as you know when we add content to the library it makes it easier for us to convert new customers because there’s more great stuff that those customers can find and we get better retention. And so definitely we are seeing a positive network effects in the business right now and that’s one of the things that gives us confidence in our outlook.

Tim Bixby

I think that adding content to library is a good indicator of overall health. It’s not sort of a one-to-one or direct correspondence with financial results but it’s a good indicator over time, maybe not a quarter but multiple quarters and years where we constantly add we have a fresh library where people are more likely to find what they need. And so you want to see that continuing to grow over time but I would hesitate to maybe draw direct lines in short periods.

Youssef Squali – Cantor Fitzgerald

Yep, okay, that makes sense. And maybe just, Jon, in your prepared remarks you talked about your belief that you guys are gaining share – I was wondering if you can maybe expand on that a little bit? What are you seeing competitively that either makes you more comfortable or maybe it’s status quo versus what you guys are seeing here in the IPO process. Thanks.

Jon Oringer

Well, we know that selling two images is more than anybody else in our space. We know that we have more data than any of our competitors because of the amount of downloads and images we serve. All this adding up kind of gives us the impression that we are taking more share than others. A lot more customers are tending to move from commissioned to marketplace and from traditional to marketplace because our model is so easy to use.

Youssef Squali – Cantor Fitzgerald

Okay, thanks a lot.

Operator

And with that, ladies and gentlemen, that’ll conclude today’s call. Thank you very much for joining us and you may now disconnect. Have a good day.

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